The forced shutdown to reduce the spread of COVID-19 is causing significant harm to the economy. The data on the effects is just starting to come in and, to be sure, the data will get worse before it gets better. Despite this, an argument can be made that the worst for equities is already behind us. Please understand that we do not try to predict market bottoms or time markets, but with all of the negative news out there, I thought it would be informative to consider a potential positive. Remember the markets do not mirror the economy, so even though growth continues to decline, markets can move in an upward trend. As a predictor of earnings growth, Wall Street begins recovering well before the economy shows signs of growth and vice versa. During the Great Recession, stocks began declining wellbefore the economy started weakening. Stocks anticipate, rather than wait. This is evident by the quick advance in the past few weeks.
During our long, just-finished bull market, an argument was made by many that Wall Street was out of touch with reality and the market’s uptrend was not sustainable. Of course, following that advice would have cost investors dearly. There are always prognosticators contradicting what the markets have to say.
While the Great Recession’s cause is very different to what we are experiencing today, a look at how the market responded versus economic activity may be a useful guide. During that period, the U.S. economy contracted by 8.4% in the 4th quarter of 2008, 4.4% in the 1st quarter of 2009, and 0.6% in the 2nd quarter. Peak unemployment was still months away and S&P 500 earnings were about halfway through a nine-quarter decline. However, on March 9, 2009, the bull market began. The economy did not start showing signs of growth until after July and grew 1.5% in the 3rd quarter and 4.5% in the 4th quarter.
Obama’s economic stimulus plan instilled confidence and stopped investor panic. Congress approved the American Recovery and Reinvestment Act (ARRA) on February 17, 2009. Consequently, the market started recovering three weeks after the stimulus was passed and months before economic data started to improve.
The official CARES Act just passed puts fiscal policy stimulus at roughly 9.4% of GDP. Combined fiscal and monetary policy actions are now approximately 20.8% of GDP. This stimulus provides significant support which should hasten a recovery.
Based on history, stocks on average bottom five months before a recession ends. By that logic, the recent rally implies a recovery taking hold at the end of August. Such a timeline might be optimistic and assumes we begin returning to work in numbers in the 2nd quarter. A lot has to go right for this to be true, including faster and better testing, but it is not out of the realm of possibility. And the bottoming of the market five months prior to a recession’s end is simply an average. There have been many times when the markets have begun recovering well before that timeline.
During every bear market, there are bull runs like we have seen, only to lead to more weakness. However, the breadth of the advance is heartening and the adage that you shouldn’t fight the Fed comes to mind. When the Fed is loosening, money flows into the economy and part of that money finds its way into the markets. Of course, the opposite is true when the Fed is tightening.
Right now, the Fed, Congress and the President have added an unprecedented amount of stimulus that will not only cushion the economic blow, but also improve investor sentiment. During March, roughly $680 billion was taken out of the market and placed into money markets. Therefore, there is a sizable amount of money looking for a time to reinvest.
To be sure, even if the market hit its low in March, it does not mean that it will not retest that low or that volatility will abate anytime soon. But, if this is the case, the question that comes to mind is, how should we react? Speaking for Washington Trust, we remain committed to our disciplined approach. We are looking for long-term opportunities that are arising due to the changes in prices and prospects. We continue to hold our risk management strategies because they enable portfolios to achieve better returns for the risk they assume. Our dynamic hedge remains in place based on the research that supports the strategy. To remove it now would be a call on the market, and as I have noted before, we are not market timers. We will remove the strategy and return to our neutral stance once the market signals that stress has returned to normal, as evidenced by the VIX Index.
The sooner we overcome COVID-19 and return to work, the greater the chance that the lows have been seen. So, let’s continue to stay socially distant and return to health as soon as possible.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Rick Cloutier, PhD, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his BS from URI, MBA from Boston University and PhD from SMC University.