BRIDGING THE GAP
Yesterday the market suffered its worst drop since Black Monday in October 1987. Trading volume was high as signs of panic selling appeared. Assets that have been “safe haven investments” like utilities and gold were sold down as margin calls and low liquidity forced leveraged investors to the exits.
Monday’s action left the S&P 500 down 26.1% year to date. I haven’t seen an official statistic but this fall from record highs to bear territory has to be one of the fastest on record.
Over in the fixed income markets, the plunge in oil prices has hit debt heavy small and midsize producers’ cash flows particularly hard. Add in the business slowdown from the virus and there are a lot of balance sheets feeling some pressure. Lower quality bonds are seeing bid – ask spreads widen as banks and other dealers pull back from the markets to reduce risk.
Meanwhile the virus casts massive uncertainty over the economy. That the US will experience at least a mild recession (a recession being defined as two consecutive quarters of negative GDP) seems certain. Earnings estimates are total guesses, making it difficult to assign reasonable fair values to stocks.
The market news and general headlines are really unnerving. It’s critical to step back think about what is really happening and not be driven by emotion.
First, the markets are functioning relatively well, despite the heavy selling pressure. Unlike 2008, the “plumbing “ of the market is in good shape. Banks are much better capitalized. While the Federal Reserve has cut interest rates almost to zero, it has also moved to provide ample liquidity to the financial system as companies draw down lines of credit.
This morning (Tuesday) the Fed has moved to support the commercial paper market, easing short term financing needs. The failure of this market was a major cause of the financial crisis of 2008.
The Fed has also said very plainly it will do whatever is needed to support the financial system. They are determined to keep a health crisis from becoming a financial meltdown.
As discussed in the last newsletter, the Fed and monetary policy have done about as much as they can, It is time for fiscal and policy responses from the Administration and Congress. After some delay, both branches of government are stepping up with major relief programs and testing and health initiatives.
So, while we have a difficult six weeks or so ahead, it is a passing event. The key number to watch is the rate of growth in new cases. The total number of cases will be increasing, but when the rate of new infections begins to slow, the situation will begin to improve quickly.
As always, should you have questions or concerns, please call us.
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