Flawless to Hopeless
Posted on Sunday, March 8th, 2020
Markets reaction is a function of economics AND emotions.
In the world of investing perception often swings from Flawless to Hopeless.
You can’t control markets but you can control the risk you take. Part of appropriate asset allocation and risk taking is diversification. Diversification has worked out well in this market disruption. Bonds and gold have held up well and those gains have helped lessen the impact of our equity positions. Also, in the last two weeks, Europe, Japan and emerging markets have been impacted less than the S&P 500 here in the United States. Those sectors have outperformed the S&P 500 by between 200-400 basis points. Diversification is the only free lunch in investing.
The virus has us more worried about the contagion in the debts markets, specifically, the leveraged loan and corporate credit areas. Those areas now have increased default risk. The marginal buyer driving stock prices for the last decade has been corporations and the corporate buyback. That buyer is now is at risk. Any increase in defaults or lack of access to capital could impede corporate buybacks. A dent in the corporate buyback regime could put a serious crimp in equity returns for months to come.
We posed the question last week. Are we still in a bull market for stocks? A correction of 10% or more should happen every other year. The last one that we had was in February 2018 -so this one has arrived right on schedule. Markets tend to repeat patterns. The reason that they do is the market is populated by human beings who make not only economic decisions but emotional ones as well. A stock market that sells off in a panic as violently as this one tends to bounce at what we would term “oversold” levels. That was the 2855 level on the S&P last week. The market tends to test its peaks and valleys. The market bear were tested this week in a run by the bulls. During its rally last week the S&P 500 was only able to recover 50% of its selloff from its peak. The fact that the bulls were not able to recover more than 50% of the selloff and maintain those gains tells us that perhaps there is more selling to come.
Why don’t we just get out of the market? One – Time is money. Time spent out of the market is time we are not making money in interest and dividends. Two- No one can time both getting out AND getting back in. We tend to be bears or bulls emotionally. Bears will get out the market at peaks but stay out of the market for years out of fear of markets heading lower. We know from history that markets tend to go higher on an annualized basis the majority of the time. That is a bet we wish to make. Jumping in and out of the market increases our costs, our taxes and decreases our chances of being right long term. We stay bullish longer term but, instead, hedge our bets using cash, bonds, options and gold while rebalancing at market turning points.
We suspect that we could be in a down cycle for the next 18-24 months as the virus takes its course. We have looked for comparisons to this outbreak and we are looking to the Hong Kong Flu of 1968 for clues. That outbreak lasted the better part of two years and killed 1 million people worldwide. While, we don’t expect the deaths to remain the same we think that the timing gives us a clue as to how long this outbreak may be with us. Our caveat to the down cycle of 18- 24 months is that we could just move in a sideways price range for that time. We might have support on the downside but the upside would also be limited. We are looking for leadership in pricing and that direction in coming months could include more gold and moves towards European and emerging market equities. In the near term, markets are in danger of falling from our current level around 3000 on the S&P 500 and retesting the previous lows of the crisis of 2855.
In case the virus wasn’t enough to consider OPEC could not come to terms this weekend and now there is a full- fledged civil war among its members. Saudi Arabia has announced that they will flood the world with oil. Crashing prices in the oil patch will conflagrate the corporate debt issues even further threatening the marginal buyer – the corporate buyback.
There are 500 cases of the virus in the US although we think that number is multiples higher. The math is astounding. If these cases rise – as we expect them to- by the time we write our next blog there will be 1000 cases in the US. A week later there will be 2000. Then the numbers really take off. The Federal Reserve and other central banks may be forced to begin large scale asset purchase to slow the markets. That could stem the tide for the time being in asset prices. We don’t know but we can plan. Markets tend to go higher over time. The US has been a great place to invest for over 100 years and I don’t think that changes now. In fact, this crisis will drive more business to Europe, emerging markets and back to North America. Unfortunately, it also may drive inflation higher in the months and years ahead. We plan to invest accordingly.
The way to tell whether the discounting has been fully reached is when the market stops reacting negatively to every bad headline, which has yet to happen. But once it happens, the market can truly bottom and begin to recover when some of the expected negative events fail to materialize, even though it may rally in the face of other “bad” news it already discounted. – Jim Bianco Bloomberg 2/28/2020 Bianco Research
I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd Blankfein
A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty. – Winston Churchill
To learn more about us and Blackthorn Asset Management LLC visit our website at www.BlackthornAsset.com .
Disclosure: This blog is informational and is not a recommendation to buy or sell anything. If you are thinking about investing consider the risk. Everyone’s financial situation is different. Consult your financial advisor.