Covid-19 Diary Number 9 (July 31, 2020)

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Frequently in these posts, I have warned against market timing.  Though timing buy-and-sell decisions of individual stocks can have merit, timing such decisions in anticipation of moves in the overall market is simply too dangerous and is as likely to produce failure as it is success. By contrast, buying and holding a portfolio of stocks for the long term puts history and probabilities on your side.  The timing temptation is nonetheless ever-present and is especially intense in times like now, when the pandemic has birthed extreme market volatility.  So this might be a good time to explain exactly what an investor is doing when he or she decides to time market moves.

 The ultimate theoretical commentary on this subject comes from Prof. Burton Malkiel’s A Random Walk Down Wall Street. In this book, first published in 1973 and the latest edition in 2019, he argues that most investors continually digest the endless flow of information coming from the economy, politics, and specific bits of business news, and use this information to assess existing stock prices and whether to buy or sell.  But these continual price adjustments, the professor demonstrated, happen almost instantaneously; and because no one can know the next bit of news, the market appears to move in a random pattern from day to day, even moment to moment (hence the title of his book).  Whatever you see in the news, Malkiel demonstrated, the market has already digested and adjusted stock prices.  There is no way to get ahead of the process.

Much of the financial community agrees with Malkiel, though these practical men and women hesitate to describe the market’s reality in quite the definitive way he does in his theoretical exposition.  Sometimes, they say, some people can anticipate market moves, and not all moves are entirely random.  To make the point, Wall Street tells a joke at the professor’s expense: If you are walking down the street and see a five-dollar bill on the pavement, the good professor will tell you that it really isn’t there, that someone else has already picked it up.  The Wall Street crowd claims that sometimes the five-dollar bill really is on the pavement – meaning you can sometimes have a sense of the market’s next move.  Still, most practitioners understand Malkiel’s point and warn that timing efforts are always fraught.  To see why, consider how market timers implicitly claim to possess one of two nearly impossible abilities:

  1. The timer effectively claims to know the news before the fact. If this timer sees good news coming, he or she buys in anticipation of the market’s coming upward price adjustment.  If that timer anticipates bad news, he or she sells in order to re-buy at lower prices when the market gets the news and adjusts prices downward.  This market timer is acting on the assumption that he or she can see the future – a most dubious claim.
  2. The market timer may not claim an ability to see the future but effectively asserts that the mass of investors operating in the market have collectively misjudged the meaning of the available news and accordingly have priced stocks incorrectly. If this timer thinks that pricing is too low, he or she buys in anticipation that the market “will come to its senses” and adjust prices upward, regardless of the continuing flow of news.  If the timer thinks pricing too high, he or she sells in anticipation of the opposite adjustment.  Here, too, is a dangerous arrogance that the market timer knows better than anyone else where pricing should be.

Such insights – whether on the future or on appropriate pricing – come rarely and are as likely to be wrong as correct.  Acting on market timing is always dangerous.  Sometimes, however, investors show such irrational enthusiasm, or such unlikely despair, that the claims behind an investor’s timing decision do not look as outrageous as they otherwise might.  In such rare cases, timing may have a place, but even so, investors should not kid themselves about the risk involved.

COVID-19 Diary Number 8 (July 14, 2020)

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It seems that many people have begun to see the market rally as an opportunity to get out whole, or nearly so, after the frightening losses of late March. They despaired three months ago when stock prices went off a cliff, and now that prices have regained much of the lost ground, they wonder if they should get out while the getting is good. They don’t have reason to forecast another plunge in values; they just want to avoid the pain of another March experience.

Such anxiety is understandable.  March’s stock price retreat was unnerving and no one wants to go through that again.  But before selling out, investors should consider two things:

  1. Do they have an immediate need for the money? If they do, then the recent price recovery is a wonderful opportunity for them to get out of stocks –– not because prices have risen, but because (as readers of these blogs should know well), they should not have been in stocks in the first place.  Equities are only for those who have no need for the money for at least five years.
  2. If they do not need the money now or for the foreseeable future, they should consider the investment alternatives. There are five choices, none particularly attractive compared with stocks.  Though some might offer less volatility than stocks, the cost to the investor is lower potential returns:

–Cash is one option.  Cash deposits and certificates of deposit (CDs), unlike stocks, offer assurances that you will get your money back no matter when you want it. But these “cash vehicles” pay extremely low returns.  Deposits — whether at commercial banks, savings banks, credit unions, or money market mutual funds — all pay less than one percent a year.  CDs pay a little more, but you must tie up the money for at least a year to get that higher rate of interest –– and you will pay a penalty if you take it out early.  This post will give you more detail.  In all cases, the returns on deposits are less than the rate of inflation.  The cost of living, in other words, is rising faster than what the investor can makes on deposits of any kind.  The real buying power of what you invest in these instruments will decline, even though the dollar amounts you get back will rise. 

–Quality bonds offer yields above the rate of inflation, but only slightly.  That might have an appeal, but the yields are still low.  What is more, the odds are good going forward that the yields will rise, which means that the bonds you buy today will lose value tomorrow.  For an explanation, see this post.

–You can get a higher rate of return if you are willing to invest in the issues of companies that are less credit-worthy.  But when you invest in these so-called junk bonds, you risk fluctuating prices or even the outright bankruptcy of the issuer, which makes this alternative as volatile and emotionally fraught as stocks.

–You could turn to commodities — precious metals, industrial metals, foods, etc.  If the economy does well, these prices will rise, as will stock prices.  But as with stocks, there is a significant downside on commodity prices should economic prospects deteriorate.

–You might take your investment funds overseas. Stocks and bonds in other developed markets — Europe, Japan, Australia, Taiwan — have all the same potentials and risks as those in the United States, so they hardly offer a haven for those wanting to flee volatility.  They do have a place in a portfolio, as explained in this post but they are not a hiding place for the frightened.  Emerging markets, as explained in this same post, have appealing long-term characteristics, but are actually more volatile than U.S. stocks.

If you want to be “cute” and take the risk, you might take some money out of equities and sit on it in the expectation that some future disappointment will bring a stock price retreat, and then you might redeploy that money effectively. I described this strategy here.  “Cute” is the best way to describe it, because it violates the basic principle that stocks are for the long term, and no investor, no matter how clever or well informed, can time market swings.

 

COVID-10 Diary Number 7 (July  8, 2020)

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Would negative interest rates help the economy recover from anti-virus strictures and propel the stock market rally?  President Donald Trump seems to think so.  He has publicly pressured Federal Reserve Board (Fed) Chairman Jay Powell to pursue just such a policy, saying that the country deserves the “gift” of below-zero interest rates.  Though the Fed has readily brought short-term rates down to nearly zero, it has thus far resisted moving them still lower. Powell has said that the monetary actions already in place will do a better job of fostering a strong economic recovery.  In this dispute, the weight of economic good sense would seem to lie with the Fed, but the struggle will turn more on political than on economic matters, especially on the political optics of an economic re-opening.

Before examining prospects for negative interest rates or the reasoning on each side of this debate, let’s review exactly what negative interest rates are.  They do not demand, as some have suggested, that banks or other lenders actually pay borrowers for the privilege of extending them credit.  They are instead a result of movements in bond markets.  Here is how they work:  A government or a large and secure corporation issues a bond at a very low coupon –– that is, stated –– interest or with no interest attached to it at all.  Effectively, the issuer promises the bond buyer to return only the initial amount borrowed when the bond matures.  When bond buyers are flush with cash and also have concerns about defaults on anything but the most secure credits, they could so increase the demand for such quality bonds that they bid their price above the amount that the borrower promises to repay at maturity.  These bond buyers then, if they hold the bond to maturity, will get less back than the premium price they paid for the bond.  That constitutes a negative interest rate.

Trump’s motivations for making his demands are clear.  He wants to get re-elected and thus wants as much immediate economic stimulus as possible, regardless of all other considerations.  In this respect Trump differs not at all from all presidents before him.  He may feel even more such pressure than past presidents because he will have to carry the lingering economic effects of the pandemic into his re-election campaign.

But the Fed is not running for office and so it takes a broader, longer-term approach to policy, as its charter demands.  Thus it views negative interest rates through the prism of at least four considerations:

  1. It can see a need for stimulus to bring the economy back after re-opening, and it recognizes the immediate stimulatory potential of negative interest rates.
  2. It can also see –– from the experience of other countries –– that negative interest rates have more often than not failed to generate much economic response.
  3. The Fed also worries that negative interest rates will distort financial decision-making, because their unusual nature can undermine the rules of thumb and formal algorithms commonly used by traders and investors.
  4. An additional concern is that negative rates now will strain bank finances, especially because the anti-virus quarantines and lockdowns have raised the risks of corporate defaults and bankruptcies.  It is not that the Fed wants to protect bank profits, but rather that it wants to avoid the kinds of financial failures that plagued the Great Recession economy in 2008-09.

Although neither Powell nor other Fed governors have mentioned it, there is also concern about the harm that negative interest rates might visit on business confidence.  Because the returns offered in financial markets naturally reflect returns available in the larger economy, a policy that pursues negative rates effectively announces that economic prospects are limited.  The relationship stands to reason.  When returns to economic endeavor are high, businesspeople will happily borrow in order to pursue those returns and that borrowing in turn will push up lending rates in financial markets.  When returns to economic endeavor are low, business has no appetite for expansion or for borrowing, no matter how low interest rates are. Low and especially negative returns hint at this sad economic condition.  When countries such as Japan and Germany pursue negative interest rates, they suggest some deeper economic malaise, perhaps the need for regulatory reform or a change in trade policy or in labor law to raise returns available to economic endeavor.  Monetary policy, even if it forces negative interest rates, cannot answer such needs. To be sure, very low interest rates say something similar, but negative rates are a thing apart.

With all these considerations in mind, Chairman Powell has countered the president’s pressure by pointing to the lower risks and greater efficacy of monetary policies already in place.  After all, the Fed has brought short-term interest rates down to nearly zero, so that it is effectively costless or very inexpensive for businesses to borrow.  Under the broad heading of “quantitative easing,” the Fed has also entered financial markets through a number of programs to provide copious liquidity for individual and business borrowers, as well as municipalities and states.  All these measures should help protect the stability of financial markets, Powell contends, and promote a robust recovery as anti-virus strictures lift.  They will do so, he implies, without the distorting risks introduced by negative interest rates.

Whatever the economic fundamentals or the experience abroad, the dispute between the president and the Fed will play out in the political, and not the economic, arena.  If the economy responds smartly to the re-opening efforts, a gratified Donald Trump may look at the coming election with greater optimism.  Needing less help from monetary policy, he may likely ease the pressure on the Fed.  But if the economy fails to respond adequately to the re-opening and unemployment remain high, Trump, in his increasing desperation, may redouble the pressure on the Fed, making negative interest rates a greater likelihood, regardless of the reasonable reservations of Chairman Powell and the other Fed governors.

 

 

 

COVID-19 Diary Number 6 (May 30, 2020)

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I started these “COVID-19 Diary” posts on April 1, shortly after the quarantines and lockdowns began.  Much has happened since then, including five posts trying to explain events as they occurred.  Now that those strictures are beginning to lift, it seems appropriate that this sixth post remind readers why things unfolded as they did.

At the time of my first entry, infection and death rates in this country were close to their peak.  Of course, no one at the time could say with any certainty they would not rise higher –– speculation in the media and even within the scientific community in early April was all over the map.  It wasn’t difficult to believe that the United States and the world were on the brink of something like the Black Death, which destroyed a third of Europe’s population in the middle of the fourteenth century.  Leading up to my April 1 post, financial markets, if they were not anticipating the Black Death, certainly feared something pretty awful.  From their highs on February 20 to their lows on March 23, stock prices, as measured by the popular S&P 500 Index, fell a steep 33.7 percent, giving up all the ground gained in the previous two years.

Even in early April, when U.S. deaths and hospital admissions reached their highs, there were hints that the pandemic here, even if it worsened, would not do so at its previous pace.  These were only straws in the wind, but they were enough to convince some investors to reconsider, if only partially, their earlier decision to anticipate the worst –– not necessarily to become optimistic, but to reassess their earlier degree of pessimism.  With that, stock prices began to lift off their lows.  By mid-April they had regained almost half the ground they had lost in February and March.  Yet it was about then that evidence emerged showing how economically devastating the lockdowns and quarantines were becoming.  Initial claims for unemployment insurance, for instance, were running at over 3 million a week, more than ten times anything anyone had ever witnessed.

The juxtaposition of stock market gains with such difficult economic news sparked media speculation.  Some stories claimed mystification by what they termed the “decoupling” of financial markets from economic reality.  Some headlines, in a style reminiscent of conspiracy theories, suggested that, somehow, Wall Street was benefitting at the expense of the rest of the country.

In retrospect, none of the market’s actions seem strange at all, and for readers of these blog posts they should not have seemed strange even as they were happening.  Markets, after all, had priced in bad news long before any bad news was available.  By the time that anticipated bad news had arrived, many investors had begun to look beyond the economic pain of the emergency.

Now, early in June, the course of the disease and the steps to reopen the economy seem to have validated the market’s April reconsideration of its earlier pessimism.  But the future still holds considerable uncertainty.  Infections will doubtless rise with the economic re-opening.  And if they rise to levels that require a reintroduction of quarantines and lockdowns, then markets will have lost the basis for their optimism, and they will retreat accordingly.  Even if the level of infections remains manageable and there is no re-imposition of severe anti-virus strictures, the economic recovery might still disappoint.  Though politicians paint a pretty picture, many restaurants, retail facilities, and other firms may never reopen, thus denying the economy those facilities and jobs for their former employees.  Recovery then will demand more than just a resumption of former activities; it will demand rebuilding, a much slower and more arduous process. I do not doubt that the economy will eventually recover, but the speed of the recovery remains very much in question, and market prospects hinge on that consideration.

Stock and bond prices, then, remain vulnerable, both to bad news on new infections (especially if they require a relapse into quarantines and lockdowns), and to the pace of recovery.  The inevitably uneven flow of information will, unavoidably, create moments of fear in the investment community and these will drag down stock prices.  But because the economy will eventually recover, these moments should present long-term buying opportunities.  But I remind readers of this blog that those opportunities belong only to those who can invest over a longer time horizon.

Covid-19 Diary Number 5 (May 26, 2020)

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The Labor Department’s jobs report for April offered official confirmation of what we already knew: the U.S. economy is in deep trouble.

Though this collection of data is the worst since the Labor Department began this statistical series in 1957, the official report probably understated the extent of the economy’s troubles.  It showed that the nation’s payrolls fell by more than 20 million workers last month and that the number of unemployed increased by 16 million, to 14.7 percent of the country’s workforce, and that some 4 million of the men and women who lost their job last month have given up trying to find new work.  At the same time, a different Labor Department report announced that in the last seven weeks almost 40 million Americans applied for unemployment insurance, implying an unemployment rate of well over 20 percent, a figure not seen since the Great Depression.

The details included in the Labor Department report offer new evidence of how widespread is the economic pain:

  • Payrolls dropped in all but 5 of the 176 work categories and subcategories used by Labor Department statisticians.
  • Of the few sub-categories that showed an increase, the only one worth mentioning is the 4.7 percent rise in “warehouse and distribution center” employment. (There should be no trouble guessing which firm dominates that.)  A miniscule rise in employment for “messengers” and what the Labor Department refers to as “other information services” are doubtless related to the rise in deliveries.
  • The only other area reporting a rise in payrolls was the federal government, where payrolls increased a mere 1,000 on a base of close to 3 million employees, a rise of less than one tenth of one percent.
  • Other government areas made cuts –– local government in particular –– trimming payrolls by some 800,000 workers, or some 5.4 percent, mostly teachers and school administrators.

The private sector, which employs some 83 percent of the country’s workers, saw its payrolls drop some 19.5 million in April, a stunning 15.1 percent:

  • Manufacturing dropped 1.3 million workers, 10.7 percent of the number they employed in March.
  • Construction payrolls dropped by just under 1 million, a 12.8 percent fall from March.
  • Services, a large sector, were hit harder, with a loss of more than 17 million jobs, or nearly 16 percent, from March.
  • Within the services area, the greatest damage was in “leisure and hospitality,” where payrolls fell by almost half or about 8 million.
  • The relatively small subsector of childcare shed about one-third of its employees –– slightly over 1 million.
  • Considering that Covid-19 is fundamentally a medical emergency, it is striking that healthcare payrolls also fell, by some 2 million, or 8.7 percent from March levels. Apparently the country’s concentration on the virus has forced a cut in other medical services, especially elective surgery.

When the May jobs figures become available June 5, they will show still more economic damage. Probably the erosion from April to May will fall short of the steep slide reported for last month, but the data will still describe a worsening situation. Markets may take this news hard, because investors have been focusing on how the economy might come back in a re-opening.  But a retrenchment in the face of a hoped-for re-opening might provide a buying opportunity. Because a quick and robust recovery remains a very open question, investors would do better not to focus on market timing but concentrate on the longer-term future, which, despite today’s intense fears, provides greater assurance of a successful market recovery.

COVID-19 Diary Number 4 (May 5, 2020)

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The president and several governors have begun considering, and in some cases beginning to end, the worst of the lockdowns and quarantines in the effort to reopen the economy.  It is none too soon.  As readers of this site know, the strictures to “flatten the curve” of infections and hospitalizations threaten economic collapse.  Dr. Anthony Fauci has described these strictures as “inconvenient.”  No doubt he means to sound sympathetic, but the lockdowns and quarantines are far worse than inconvenient.  These rules have attacked the essence of people’s lives, perhaps not as medical people and epidemiologists understand it, but surely as most people do.  It is a step far beyond inconvenience when some 30 million Americans have to apply for unemployment insurance in the space of five weeks!  That is almost 20 percent of the country’s workforce, a proportion that will only increase the longer today’s lockdowns and quarantines stay in place.

California has led in outlining the move back to work and it has identified specifics that would allow it.  That huge state is not alone.  President Trump and other states – governors in the Northeast acting in concert – have also indicated a path to economic reopening, as have various think tanks and advisory bodies.  These suggestions vary in detail, but each effectively foresees a three-stage process through which public health developments  — what the White House calls “gating criteria” — will allow a relaxation of today’s constraints and hopefully begin a return to former levels of prosperity.

Presently we are in the first phase and have been since mid-March. Here are its salient features:

  • People have been pressed to stay at home regardless of their vulnerability or symptoms.
  • Businesses have been shuttered, except those designated “essential.”
  • All states have banned large gatherings.

Without easy widespread testing, these and other aspects of this strict phase were the only way to guard against random infections and run the risk of overwhelming existing healthcare facilities.  Though the lockdowns and quarantines have been necessary, they have thrown millions of Americans out of work, most especially in the retail and hospitality industries, but also in manufacturing and professional services.

Current plans call for a continuation of this phase until at least mid-May.  Easing can occur, the authorities say, only when a state or region can see specific changes, the most significant of which are:

  • An ebb in new cases and a drop in hospitalizations. The redoubtable Dr. Fauci has characterized this easing as a concerted drop in new cases and hospitalizations over a 14-day period (the time over which an infected person will develop symptoms).  That hopeful sign, he and others have said, has begun to be in evidence, though no one is making any promises.
  • A transition would also depend on the ability to do widespread, same-day, point-of-care testing, even of the asymptomatic, in order for authorities to isolate only those who are sick. One researcher said an ability to do 750,000 tests a week would be a reasonable number.
  • Easing would also have to wait until healthcare facilities were considered adequate to handle a new spike in cases should it occur, and the necessary step of setting up contact tracing (as New York State has already begun) of those who have been infected.

Different states or regions will take such reopening moves at different times, and some states are coming up with their own interpretation of these steps—Georgia and New York being different examples; Georgia as of this writing opening up, while New York is still pretty much in lockdown.  Where they do open up, the authorities could still impose restrictions.  Some that have been proposed are:

  • Individuals identified as vulnerable would be urged to isolate, and there is some discussion of subjecting them to GPS tracking.
  • Rules would still forbid large gatherings
  • Restaurants would have to reconfigure to allow socially distanced (however defined) seating.
  • Staff at restaurants and other retail outlets would wear gloves and facemasks, and perhaps more protective gear.
  • Offices might reconfigure to make the by now famous six-foot separation distances easier to maintain.
  • Offices and factories might include temperature scanners as well as firm-wide testing for Covid-19 antibodies.
  • Airlines might forbid any passengers until six weeks after virus dissipation. Most major US airlines are already making passengers were masks during flight.
  • Sanitizer dispensers will become even more ubiquitous.
  • State parks and other facilities will reopen, but only to people who wear masks and arrive in groups of five or less (as Texas has already mandated).

The full reopening of economic activity — the final, third phase — would wait for a vaccine.  The authorities in California and elsewhere also include what they call “herd immunity” as a trigger for this phase.  (This is a slippery term that appears to mean that the population has had widespread exposure to the virus, that those who will succumb to the virus are no longer a concern, while, presumably, the majority of the population has developed immunity.)  Only then would the authorities allow us return to our former economic lives, and only then would the economy have the opportunity to recapture its pre-pandemic prosperity.  But forecasts on vaccines are by definition difficult.  Researchers are hopeful they can shorten the timeline, piggybacking on previous research on other viruses.  Estimates now say a vaccine for healthcare workers may be available by late this summer, or early fall, and by early next year for the general population – a long time to wait for full employment.

If this reopening proceeds in a promising way, it can only help financial markets build on their recent gains, most of which have come in anticipation of some progress on the virus and thus a good promise of economic relief.  There is the possibility, however, that given the way things go in the real world, some mishap (say, either a rise in cases or a miscalculation on easing restrictions) would create a period of market fear and accordingly a retreat.  As always in such events, good investors will keep their eyes on the longer term, and resist the temptation to give into fear.  Such a fearful moment might even present a buying opportunity, though, as my readers now should know well, I never advocate trying to time the market.

 

 

 

 

COVID-19 Diary Number 3 (April 20, 2020)

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The unemployment rate reported by the Labor Department for March understates, by a long shot, the nation’s economic pain.  According to the official report, non-farm payrolls last month fell 701,000 and the rate of unemployment rose from 3.5 percent in February to 4.4 percent. The actual figure is that closed businesses and quarantines likely reduced payrolls nationwide by 12 million in the last the last two weeks of March alone.  During that time other Labor Department reports show that more than 10 million applied for unemployment benefits, something for which not all the unemployed qualify.  Because the workforce of the United States numbers some 165 million people, those new claims at least added some 7.5 percent to the existing unemployment rate, conservatively making the more likely number of unemployed in March closer to 12 percent of the existing workforce.  The figure has grown in April and will grow as the emergency constraints remain in place.

Lovers of conspiracies will accuse the authorities of intentionally understating the economic pain.  But the real reason is far less dramatic.  The Labor Department missed the extent of Labor Force damage because it bases its calculations on two surveys that are taken in the middle of each month, one of households, the other of employers.  The first asks a sample of the population whether they are working, and if not, whether they want to work.  Those working, and those who are out of work but seeking a job, give the Labor Department a fix on the size of the nation’s willing workforce each month.  Those out of work but who seek it count as the unemployed, which the Labor Department states as a percentage of the workforce. The second survey asks employers about the number of people on their payroll.  Because the worst effects of the lockdowns and quarantines did not develop until late in March, the Labor Department’s mid-month surveys simply missed most of the impact of the situation.

That will not be the case for April.  The mid-April surveys will capture the full brunt of what has already happened.  But these surveys will mislead in a different way: In addition to workers who lost their jobs in early April, we will see the accounting for the tremendous drop in payrolls that occurred in late March but which that mid-month surveys missed.  The report for April will then show a shocking surge in unemployment, much of which really occurred in late March.  Observers will be led to believe the sudden damage was all done in April and thus see an acceleration in labor market damage that probably will be far in excess of what is likely for the April part of the surveys, though the ongoing damage will undoubtedly become more severe.

I have described here a technical problem with statistical techniques that in most environments are more than adequate for the tasks set to them.  But in this pandemic environment, the misleading nature of these figures can have real-world effects on perceptions of the state of the economy and on public as well as business confidence.  The burden is on the Labor Department and the Trump administration to clarify the figures so the public is not misled in April and again in May when the responses to the April survey become available.

COVID-19 Diary Number 2 (April 6, 2020)

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Though no one can yet say how the virus will continue to develop in the U.S., and therefore how the markets will go, a review of the past few weeks can allow this conclusion (with apologies to Winston Churchill at the end of the Battle of Britain): This is not the end or even the beginning of the end, but it is the end of the beginning.

Whenever markets suffer a shock – a collapse somewhere in the economy, natural disaster, war – participants panic.  This happened in March as the extent and severity of the Covid-19 pandemic became apparent.  Such panic could of course return if markets were to suffer another terrible surprise, but their recent behavior suggests this beginning phase of the market correction seems to have ended:

  • Equity prices have clawed back some of the ground lost to March’s panic. Stock prices fell precipitously between February 21, and March 23, with the benchmark S&P 500 stock index sliding almost 35 percent in just some four weeks, wiping out all the impressive gains of the prior three years.  Since then, investors seem to have recovered the sense that perhaps pricing had anticipated the worst, especially since the Federal Reserve (Fed) and the government have initiated policies to mitigate if not erase the recessionary effects of the measures needed to fight the spread of the virus. Pricing has begun to improve.  Stocks have risen some 19 percent from those lows, still some 21 percent below the highs of February, but a sign that panic has passed for the moment. 
  • Bond markets, while still fearful, remain relatively stable. On the first news of pandemic, Treasury yields fell precipitously, with the yield on the 10-year note dropping from just under 2.0 percent at the end of January to just over 0.6 percent by mid-March. To a large extent, the move reflected the Fed’s efforts to drive down all interest rates and bond yields. A flight to quality also was an element here.  As investors sold off bonds issued by entities with lesser credit ratings and put the proceeds into presumably safer Treasury issues, the yields on all other bonds actually rose, widening the yield spread lesser credits offered over Treasuries from a little over 3.5 percentage points late in February to just over 10.5 percentage points late in March.  This was not as high as the 20 percentage point spread that prevailed for a while in the Great Recession of 2009, but it’s hardly a sign of confidence. (This post will brief you on how bond prices and yields interact.)  The past few weeks have seen only modest improvement.  these yield spreads have declined to some 9 percentage points –– hardly much improvement but nonetheless a tentative sign of relative calm.
  • Commodity markets tell a similar story to bonds.As the lockdowns and quarantines effectively shut down the economy, industrial materials prices dropped quickly. Copper prices illustrate the common story, falling by almost 20 percent from early to late March. Oil prices did worse, falling some 40 percent during this time, though extra pumping by Saudi Arabia (because of a dispute with Russia) exaggerated the general price retreat. Prices of oil, copper and most industrial materials have since risen slightly –– again, not a sign of confidence but at least a halt to the earlier panic.
  • Currency markets, in contrast, have all but corrected their earlier panic.  When the seriousness of the pandemic first became evident, money moved toward dollars, as it does in almost every emergency.  A global index of the dollar’s value rose some 5 percent, but has nearly returned to its level of early March.  Some might interpret this as a sign that Covid-19 infections in the U.S. have risen, but on a per-capita basis the American infection rate is no worse than in most developed countries and a good deal better than some.  The movement away from the dollar speaks to a lessening of panic.

All this could change if COVID-19 changes its course.  If it worsens, panic could reappear, and the markets would return to their levels of late March or even lose more value.  But if the effects of the disease ease and promise a return to more normal levels of economic activity, the relative calm of recent weeks suggests that markets could regain ground quickly.

COVID-19 Diary – Number 1 (April 1, 2020)

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A reader suggested that while this pandemic continues, I keep an open diary on this site with frequent short entries focusing (though not exclusively) on investment and the markets. This is the first of these posts.

Markets are less concerned about the virus itself than with the recessionary impact of the lockdowns and quarantines.  That perspective points to two considerations:

  1. Actions by the federal government, and to a lesser extent states and cities, to lessen the recessionary pressure.
  2. Because the longer the lockdowns and other restraints remain in place, the deeper into recession the U.S. economy will sink and the longer and harder it will be recovering, markets necessarily also consider how long this period of restraint will last.

Washington—that is, the government and the Federal Reserve––has now delivered large (more than two trillion dollars) and well-crafted policies to deal with the recessionary dynamic. While these moves cannot ensure the economy will escape the pain of a recession, they do offer good reason to hope that the future will be less severe than it otherwise might have been.  The markets rallied in response, actually in anticipation of this welcome news.

The news on the duration of lockdowns and quarantines is less encouraging.  President Trump has given up on his “hope” that the nation could get back to work by Easter, and he extended the advice to keep things shut down until April 30.  He may have to extend it further because new Covid-19 cases are multiplying in the U.S.

  • The global picture does offer some hope. The tracking system administered by Johns Hopkins University reports that new Covid-19 infections peaked on March 27 at 67,400 and in the following two days fell about 10 percent.  But we must keep in mind that this picture of abatement is really tentative.  At other times we have seen such improvements only to face a new surge.
  • For the U.S., the picture is less encouraging. On March 31, the World Health Organization reported that the nation suffered some 19,332 new infections, nearly five times the number reported on March 27.  Yet these figures may not be as bad as they appear.  In just the last few days, the country has made considerable headway in testing – not as much as the experts say is needed, but an improvement nonetheless.

Investors should keep in mind that the nation will survive this pandemic, as will most of its businesses.  Those who bought equities for the long term (which, as so many of these posts have emphasized, is the only way to buy stocks), should keep that “long term” in mind and hold on for the inevitable recovery.  Panic selling now will only deprive you of the opportunity to take part in that recovery.  For those who have cash, the present market setbacks presents buying opportunities. But because no one can know when the pandemic and its economic fallout will end, it is not possible to pinpoint the best buy.  The smart approach would be to invest in stocks piecemeal, and over time –– perhaps on each major market reverse.  Investment professionals call this “dollar cost averaging”.

 

 

 

The Computer’s Role in the Recent Wild Market Swings

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Photo by ThisIsEngineering on Pexels.com

Computerized stock trading has played a not-insignificant role in recent violent stock market swings.  Of course, behind these swings are the perennial drivers of market lurches: fear and greed.  Fear rules whenever investors feel insecure or uncertain, but it’s greed’s turn when investors judge that the fear has created a buying opportunity that despite uncertainty and insecurity, they feel they cannot afford to miss.  But computerized trading exaggerates what otherwise might be significant swings into wild volatility.  We have been seeing a lot of this.

The computer’s role exaggerates market swings because most if not all of the algorithms running these programs react to the momentum of the market.  If investors begin selling out of fear and stock prices fall at a particular rate or beneath a certain point, the computers “see” further losses and “order” even more sales, thus ensuring that further losses take place.  Investors  rushing to buy a stock will trigger the computer programs to join in.  These investor moves, once they prompt the algorithms to act, become self-fulfilling and greatly exaggerated.

For those who find this unnerving, here are four things to keep in mind:

  1. For the computer, eternity begins and ends each day. They go with the momentum until the market closes (or, less likely, something like human action alters the momentum despite the influence of computer trading).  The computer action does not follow from one day to the next.  
  2. Though computerized trading exaggerates up and down moves, it has no effect on prices over time. Such trading can be an irritation for the fundamental investor seeking to meet the basic objectives often referred to in these posts, but don’t consider it anything more than that.  The market in the closing weeks of 2018 certainly demonstrated this:  Computerized trading pushed the downdraft in stock prices much further than it otherwise might have gone, and then exaggerated the upswing the following dayThe same thing is happening now.
  3. Individual investors who try to gain from computer-induced swings by buying and/or selling stocks ahead of the swings are as likely to lose as to win. Traders buying and selling algorithmically make money because computerized trading enables them to move blindingly fast –– faster than most professional investors and certainly faster than any retail investor –– that would be you.  (In fact, most of these operations have their computers physically near the exchange, because a profit opportunity can be missed in the less-than-instantaneous time it takes an electronic order to reach the exchange from, say, an office in Connecticut.)  Even at such speed, algorithmic traders can only make money by squeezing pennies or less out of a single transaction; it is worthwhile for them because they deal in huge stock volumes.  No individual investor can do this.
  4. Computerized trading violates a fundamental rule for the retail stock investor: Even without the added volatility of computerized trading, stocks exhibit considerable volatility. This is a fundamental aspect that should warn investors off stock investing if there is any chance they will need their invested money in a hurry.  If you cannot wait for the  market’s ups and downs to cancel each other out and give you the long-term positive gain of stocks, then you should not be in them in the first place.  Better to be in bonds or savings accounts.