From peak to bear, now seeking normalcy
By Kyle Tetting
The past few weeks have provided us all with a strong reminder of how quickly a bull market can end. As recently as February 19, the S&P 500 had marked a new record high amid early signs that the global economy could be reaccelerating. The potential damage wrought by the COVID-19 virus and the unprecedented actions by countries around the world to stem the pandemic’s tide caused a sudden shift in stocks.
Every bull market seems to end abruptly, but this one felt particularly rushed. From a technical perspective, the bull market ends—and the bear begins—after a 20% decline from a stock market peak. The S&P 500 entered the current bear market, our ninth since 1960, in a record 22 days. That is a far cry from the 280 days on average it took to reach a 20% decline in the previous eight bear markets.
Underlying the most recent decline has been a singular focus on the impact of the novel coronavirus with widespread implications for the market.
Most prominently, concerns about liquidity across asset classes have escalated to levels not seen since the financial crisis. On the surface, this is a troubling development, given the cascading failures a lack of liquidity caused through much of 2008.
Spreads on bonds—a measure of the premium investors demand to take on the risk of default—have spiked. At the start of the year, investors received little premium to hold even low-quality bonds. Now, holders of even highly rated bonds are demanding double or triple the premium, pushing yields higher and bond prices lower at a time when stocks have also sold off.
To be fair, high-quality bonds have held up far better than stocks, as we would expect. However, liquidity concerns and recessionary pressure have resulted in increasing correlation between stocks and bonds, a sign of distress in markets.
Despite concerns about liquidity and declines in portfolio values, there also are some signs of optimism.
For starters, banks began this crisis far better capitalized than in 2007. Stress tests outlined by the Federal Reserve showed potential cracks in the financial system that banks have responded to by strengthening balance sheets and exhibiting more responsible behavior, thus strengthening the foundation of our economy.
Perhaps more importantly, the Federal Reserve has taken swift action to return liquidity to financial markets. Using tools first tested in the financial crisis and adapted to our current situation, the Federal Reserve has instituted emergency lending programs that could provide $4 trillion or more of liquidity to the system.
On top of the Fed’s actions, on March 26, the Senate passed a $2 trillion stimulus bill aimed at supporting businesses and individuals. In addition to direct payments to middle- and lower-income individuals and families, the bill is intended to provide billions for hospitals, airlines and other businesses.
Uncertainty surrounding COVID-19 poses many questions about a return to normalcy. In the words of Dr. Anthony Fauci, “You don’t make the timeline. The virus makes the timeline.” And, the longer the virus persists, the more economic damage will accumulate.
Fortunately, coordinated efforts by central banks and policymakers can provide some of the immediate relief needed by the economy and markets. That could buy time for health experts and scientists to do the difficult work of fighting this virus—eventually allowing for a return to some semblance of normal.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Keeping balance in unnerving times, by Bob Landaas
A note on coronavirus volatility, by Kyle Tetting
Mind correlation to control risk, a Money Talk Video with Paige Radke
Headlines only part of stock market story, by Kyle Tetting
Corrections: A normal part of investing, a Money Talk Video with Marc Amateis
Talking Money: The importance of balance, a Money Talk Video
(initially posted March 27, 2020)
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