Market volatility and the lockdown's gains

To say these are unprecedented times would be an understatement. To say these are confusing times would be a vast over-simplification. The world economy has changed quickly, markets have been volatile, and the social and professional adaptation to the pandemic crisis has been remarkable.

Scenes of home-schooling, contagion modeling, and medical research are playing out across the country, and across the world, at a remarkable scale. At the same time, in the United States, more than 16 million people have filed for unemployment benefits in the past two weeks.¹ Occurring roughly in parallel, the Federal Reserve has provided trillions of dollars in liquidity. And the U.S. government enacted legislation to provide $2 trillion of fiscal stimulus (or relief, depending on your definition). All of which occurred just after the fastest US equity market sell-off in history, which was then followed by the fastest 25 percent market move up in history.

And remember, the first case of the novel coronavirus, COVID-19, wasn’t confirmed in the United States until January 21 … less than three months ago.

As such, what follows is an attempt to try and separate fact from fiction. While clearly there are differences in what we are seeing when compared with other volatile periods, there are many characteristics that rhyme as well. If we can maintain perspective and mitigate our emotional responses, perhaps we will make better decisions throughout this time period.

Accordingly, what follows is an update on how the outbreak is proceeding, and the impact to markets thus far. It is also worth noting that as the number of cases stabilizes, we are quickly going to be moving into assessing the economic impact of this crisis.

For the more impatient among us, let me begin by offering this: the lockdown is working. As we have been stating for weeks, the growth rate of new cases in the United States has slowed dramatically, and markets have responded in kind. This is great news, and yet we are not out of the woods. As the economic impact unfolds, volatility will remain, and we all need to be prepared for a bumpy ride.

Where the COVID-19 pandemic stands

Therefore, let’s begin with a quick update on the nature of the crisis. As of the morning of April 14:

1. The novel coronavirus (COVID-19), now present on every continent except Antarctica, has infected nearly 2 million people and killed more than 123,000 people.²
2. In the United States, there are now nearly 600,000 cases along with a little more than 25,000 deaths.³
3. Italy, Spain, France, and Britain all now have more than 10,000 deaths. ²

Clearly, these are frightening and tragic numbers, and help explain why this has been such an emotional and fear-driven selloff in equity markets worldwide.

Having said that, the lockdown is working, and we have seen a dramatic change in case growth rates over the past several weeks. Chart 1 demonstrates that phenomenon.

After the initial January and February China outbreak, the global case growth rate peaked at around 20 percent on March 22. That same growth rate is now around 5 percent per day. In the United States, thus far, our growth rate peaked at around 39.5 percent, also on March 22, and that same growth rate is now down to 6 percent. The impact of that difference is dramatic.

Chart 2 helps demonstrate that dynamic by converting the growth rate into the number of days it takes to double the confirmed cases.

On March 13, when the initial US lockdown (roughly) went into place, the number of cases was doubling every 2.2 days. That worsened to doubling every 1.8 days on March 20. The U.S. confirmed case count is now doubling every 11.6 days and is improving daily.

It is worth noting that Italy is now doubling every 26 days, and China has now lowered their growth rate to less than a tenth of 1 percent per day.

In short, the lockdown is having its intended effect. Growth rates of the number of cases and deaths are falling. While we don’t know how long this will last, or whether we will see another re-emergence, we can at least take solace in the fact that the status is improving.

Accordingly, as that news has stabilized (and improved), markets have responded in kind. Volatility is down, and equity markets have rallied. Between February 14 (the peak), and March 20 (the trough, so far), the Standard & Poor’s 500, an unmanaged index of large company stocks (S&P 500), was down 32 percent. If we had ignored the trough on March 20, and woke up yesterday, the market cumulatively was only down around 17 percent.⁵

As another example, the VIX Index (a reasonable proxy for fear and uncertainty) peaked at 83 on March 16 and is now back down to 37.8. ⁶

Getting better?

Through these lenses alone, the world is improving. Case growth is falling, death rates are falling, fear is falling, and markets are stabilizing.

Unfortunately, as investors, we now need to turn our attention to the next phase, which is the economic impact of the lockdown. While clearly the lockdown was required to mitigate the spread, the early indications from an economic perspective is that those consequences will be massive.

With roughly one-third of the world’s population under mandatory lockdown, and far more under some form of reduced economic activity, we are almost certain to face a severe contraction in global growth. While the impact or the length isn’t clear, we are beginning to receive early signs that the contraction will be severe.

Chart 3 helps to demonstrate one of those perspectives by showing the weekly jobless claims as a percentage of the US population (the blue line), along with historical US recessions (the gray bars).

Cautious readers will note that, as one might expect, jobless claims ( i.e. those who are filing for unemployment benefits) tend to increase during recessions. That is logical … as recessions are nothing more than a contraction of an economy. When economies contract, layoffs occur, and therefore individuals file for unemployment benefits.

And yet, what is particularly striking this time is how large those numbers are. In the last two weeks more than 16 million people have filed for unemployment benefits of some kind. When divided by the size of the population, that number is remarkably high (as can be seen from the right side of the chart).

Looking forward, we should begin to brace ourselves for what will certainly follow. As much as the Federal Reserve and the U.S. government will attempt to mitigate the impact, the data will likely be quite negative, and in many ways, hard to process.

Investment outlook

This then begs the question: what are investors to do?

Well, let’s summarize what we know:

1. The sell-off since mid-February has been unprecedented and was largely uncertainty and fear-driven. The downturn was fast, and the upturn was fast. Both the sell-off and the subsequent rally set records, and both were nearly impossible to time well.
2. The growth of the number of cases around the world is slowing, and many estimates of potential death tolls are vastly over-estimated (at least based on what we know so far). As the uncertainty has decreased, markets have stabilized.
3. The Federal Reserve is providing trillions of dollars of liquidity to ensure markets remain open, and the U.S. government is providing trillions of dollars of stimulus to help mitigate the depth of the recession. Both, in aggregate, are designed to mitigate the damage imposed on its citizens.
4. The economic impact will be great, and is, yet, unknown. Unemployment will rise, earnings will fall, and it is nearly certain the U.S. will fall into a recession. This will likely continue to create volatility, and we, as investors, are likely in for a bumpy ride as both negative and positive news battle for dominance in the near term.

As such, perhaps I would proffer that we, as a society, have simply learned we are making our way through. It hasn’t been pretty, and it hasn’t been smooth … but the changes we have made, and the structure we have in place (both diagnostic and economic) are working. Clearly there will be lessons, with processes and policies to improve … but nonetheless, we are making our way through.

From a capital markets perspective, therefore, in short, capitalism is working.

Consequently, the only logical conclusion is to stay the course. There is plenty of research that shows humans are terrible at timing the market … and thus we shouldn’t attempt to do so.

Control what can be controlled and recognize that we are investors for the long-term … not the short-term. In the long run capitalism will act as wind to our backs, and in the short run we will simply suffer its indifference.

In closing, stay safe, stay home, stay focused on your loved ones, and please turn off the investment news channels.

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