“Stocks never bottom on a Friday.” – Wall Street Wisdom
Considering the breath-taking volatility this week, the above stock market axiom seems appropriate to share. Stocks remained slightly negative on the day but rallied strong into the close. While the strength of the rally into the close is no where near an “all clear” signal, it is certainly more positive than if stocks had closed on the low of the day.
While the volatility is unsettling, or even scary, to investors, it is important to understand what is happening rather than speculating on what could happen. This means addressing the elephant in the room. Is this the beginning of another 2008/9? The answer is emphatically, no!
The Financial Crisis was a systemic crisis set off by an ENDOGENOUS catalyst (Housing market). In other words, it was a crisis that originated from within the financial system. The banks became too leveraged and the use of derivatives amplified the risk to the financial system. As banks/lenders failed the ripple effect was dramatic.
What we are experiencing now is a crisis set off by an EXOGENOUS catalyst (pandemic). In other words, the threat to the economy and markets comes from outside the system. The Coronavirus will pass. Even the most apocalyptic view acknowledges that the virus will pass sometime soon. This means the time when Coronavirus is a “non-issue” is right around the corner.
In our last letter to clients we point out one of the issues is that Coronavirus is a “pandemic” and not an “epidemic”. This means the virus spreads across boarders rapidly and affects everyone. Whereas diabetes is an epidemic. This means the number of cases is increasing rapidly but is not transmitted across borders. So, even though cancer and diabetes have led to the death of more people than Coronavirus this year, the economic impact of Coronavirus is far greater. This means, as a money manager, I am less concerned with the mortality rate of Coronavirus than I am the impact it has on the economy.
The threat of contracting influenza, cancer or diabetes does not impact the way consumers behave in the short term. Sure, the threat of diabetes will lead consumers to eat healthier, but it will not affect their travel schedule. The threat of Coronavirus will lead to the cancellation of travel, events and any number of economic events.
So, what does this mean to stocks? Well, we continue to believe the low is nearly in for stocks. The economy will slow and might even slip into recession. We believe stocks have discounted most of this risk. The jobs report today affirmed that the underlying economy is strong. The Federal Reserve lowered interest rates and is likely not finished with injecting stimulus into the economy. These factors will lead to a significant rally in stocks in the weeks/months to come.
Our baseline view for 2020 was one that pointed to strength in the economy until after the election. We felt negative influences on the economy would converge in late 2020 and lead to a recession in 2021. Well, maybe this “exogenous” force has pulled forward the recession into 2020. We are unsure at this point but willing to adjust our forecast to align with this view.
If the recession happens this year, rather than next, then we think stocks have adjusted to this reality. We continue to believe the Coronavirus will come and go. We believe the economic effect of consumers reacting to the virus will come and go. We also believe the strength of the U.S. economy is here to stay for some time to come. This means we are optimistic for the economy and stocks.
Today, for our managed accounts, we bought an airline stock. While there is no doubt that airline travel will be curtailed, it is not going away. Once the cases of Coronavirus peaks, we believe air travel will begin to pick up. Oh, and the price of oil has declined precipitously. This is one of the most significant expenses for airlines. So, when travel picks up it means airlines will be operating more profitably than ever before. We also continue to like our investment in one of the two major aircraft manufacturers in the world. It is unlikely that airlines cancel any orders as a result of this virus.
Unbelievably, as a result of the Fed cutting interest rates, homeowners can refinance (once again) and cut their debt expense. They might even take out a little equity and use it to buy a car or a refrigerator, or a second home, or whatever. Regardless, the consumer is being given another opportunity to increase their spending.
This crisis is about to get worse in terms of the number afflicted. However, it is unlikely that this virus will be around past April. This means the peak number of cases is going to be seen sooner than later and this is when the market will turn decidedly higher. Our prediction is that by July the national conversation will be over the election and rising interest rates rather than Coronavirus.
In conclusion, it is worth noting that the Chinese stock market has rallied over 6% from the low last month and now sits at a yearly high. So, the country where the virus originated has seen its stock market rally to new highs following the steep selloff it experienced when the virus became news. It is not unreasonable to think something similar could occur here in the U.S. So, while stocks may not have bottomed on this Friday, we expect it to happen soon. This means stocks are poised to go higher sooner than later in our view.
Kessler Investment Group, LLC