(Un) Happy Anniversary

Today marks the 11th anniversary of the longest running stock bull-market. Since the post-financial crisis low on March 9th, 2009 through Friday's close, the S&P 500 has returned 339%.  The record bull run also faces perhaps its biggest threat as the coronavirus outbreak spreads and an oil price war sends markets into a tailspin. Investors have begun to worry that global growth will grind to a halt.

There is an old adage on Wall Street: the market goes up the escalator and down the elevator. Stock gains tend to be small, relatively steady things, accumulating over years.  The declines are often quick and frightening.  While the stock market has eventually reached new highs after every correction, it’s still an unsettling process to go through. The capital markets have reacted sharply to the spread of the coronavirus epidemic since mid-February. The subsequent collapse in stock prices and bond yields has been abrupt by any historical standard. As a reminder, however, global equities were significantly overbought in mid-February, thereby exacerbating the downside as investors sold to de-risk their portfolios.

In other words, we would argue that some weakness in equities would likely have occurred even in the absence of the current coronavirus anxiety.  On top of falling stock prices and bond yields, crude oil prices have collapsed too; falling by as much as 31% last evening, in what was the largest single-day price drop since the U.S. invaded Iraq (the first time!)  in 1991.  OPEC’s failure last week to strike a deal to cut production prompted Saudi Arabia to lean in aggressively on cheaper oil prices. This fanned concerns over a full-fledged price war that sent oil into free-fall. Investors appeared to price in the likelihood that Saudi Arabia’s fight with Russia over market share will worsen the dramatic spiral lower in prices, taking place against a backdrop of falling demand and plentiful supply.

Investors are caught in a feedback loop of negativity, driving the S&P 500 down more than 7% this morning, a move that triggered circuit breakers to halt the slide. The market circuit breakers are designed to slow trading down for a few minutes, give investors the ability to understand what’s happening in the market, and make more informed decisions based on market conditions. We need to stress that this is operating as it’s supposed to.  The rules, which apply to regular trading hours only, are as follows:

•                     Level 1: If the S&P 500 drops 7%, trading will pause for 15 minutes.

•                     Level 2: If the S&P 500 declines 13%, trading will again pause for 15 minutes if the drop occurs on or before 3:25 p.m. EST. There will be no halt if the drop happens after that.

•                     Level 3: If the S&P 500 falls 20%, trading would halt for the remainder of the day.

These circuit breakers have never been triggered in their current form during regular trading hours, prior to this morning. The old circuit breaker system was revamped after it failed to prevent the May 2010 “Flash Crash.” The current set of breakers were put into effect in February 2013.  The last time circuit breakers kicked in on the U.S. futures market was November 8th, 2016, the night Donald Trump won the presidential election. In that instance, buyers swept in at the open and pushed the market higher. Although circuit breakers are designed to calm the nerves, they may have the opposite effect.  Heightened financial market volatility will persist and risk taking will remain subdued until there are clear signs the coronavirus is contained. Increasingly, it appears that containment requires aggressive government countermeasures; these seem to be doing the trick in Singapore, Taiwan, and (it is hoped) in mainland China and South Korea. Containment comes at the cost of brief but significant hit to economic growth. Neither monetary nor fiscal policy will be sufficient to revive animal spirits in the face of a full-blown outbreak.  The economic impact of the coronavirus will depend upon its severity and duration, which are unknown variables at this point. The good news is that social distancing and quarantines appear to work well to contain the spread; the bad news is that U.S. appears to be somewhat behind the curve.

There is little doubt that you have heard us say that asset allocation is the most critical decision in the investment process for your portfolio. Our investment strategy for each of our clients aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon. Home builders focus almost obsessively on getting the blueprints right before buying a single nail or bucket of paint. Why? Because they have learned the time-honored wisdom “an ounce of prevention is worth a pound of cure” from hard experience. When you rush to get started on a large project without proper precautions, it becomes extremely messy, time-consuming (and, in some cases) riddled with irreversible mistakes. The aim of diversification is to avoid market extremes, allowing investors to achieve satisfactory returns while both reducing volatility and the risk of suffering from a permanent loss of capital. The primary means of accomplishing this is through careful asset allocation, the practice of dividing investment money into different classes of assets -- such as stocks, bonds, real estate, and cash -- that will act independently of each other.

Equity volatility is the price we pay for capital appreciation over the long term.  If we never thought an unexpected event could cause the market to fall, we would advise putting all of your money in stocks. However, that is not how the world and markets work.  Fortunately, we can use other asset classes to diversify your portfolio to help smooth out the ride on the journey to achieving your financial goals. Like insurance, you never hope to actually need the protection, but you are surely glad you have it when something goes wrong.  Owning private investments and non-correlated asset classes help protect your portfolio from these events.  Nothing about the coronavirus outbreak causes us to question these investments in your portfolio. Our asset allocation models have performed well through this time of market stress, and we are closely watching opportunities to take advantage of market stress to add high quality investments at (increasingly) attractive prices. Over medium and long-run horizons, this strategy has always proved highly beneficial.

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