Since our last letter to you at the end of December, the world has changed with breathtaking speed. As the COVID-19 pandemic has raced around the world, economies have ground to a halt, equities markets have plunged, lockdowns have become the new normal, and everyone’s lives have changed dramatically. From our perspective as money managers, you really could not imagine a more disruptive event. When we experience disruptive events like this, we always look for similar events in the past to get an idea of what it might look like. For this pandemic, there are really no parallels. We have basically shut down our economy for a sustained period of time. That’s never been done before. Adding to the economic shock is the collapse in oil prices, which, if not for the pandemic, would be the major news event so far in 2020. We normally do not like words such as “Plummet”, “Plunge”, and “Crash”, but all three seem appropriate for describing the markets and the economy this quarter.
We have talked for the last couple of years about the bull market in stocks and that it was the longest running bull market in U.S. history. The bull died on March 11th, only 19 trading days after setting an all time high. That’s the second fastest bear market in history. The average bear market takes 136 trading days, so this drop was fast and steep. The U.S. economy, which was expected to grow at a 2% pace for this year, will likely be negative for the first quarter and then extremely negative for the second quarter. Estimates for GDP contraction during the second quarter are as high as a negative 24% annualized rate. It could be even worse than that, and we have never seen a drop that large, not even during the Great Depression. It is extremely difficult to make forecasts during an unprecedented economic collapse, so we will really just have to wait until the numbers some out to see how much damage is being done. Whatever the numbers turn out to be, they won’t be good, and will probably be as bad as economic numbers last seen during the 1930’s.
In early February, first time jobless claims were the lowest in over fifty years. Seven weeks later, jobless claims were almost 3.3 million, the most ever. Such a stunning reversal is unprecedented and could easily get much worse before this is over. We are seeing estimates that the unemployment rate may reach 30% on a temporary basis.
In response to this economic stoppage, the Federal Reserve has unleashed a $2 trillion stimulus to pump money back into the economy, doing essentially what they did during the 2008-2009 recession, except on an even bigger scale. The Fed has also dropped interest rates to zero. To state an obvious fact, until the spread of COVID-19 slows, any economic measures will have limited success.
The question often asked is, How long will this last? At this point, the answer to this question is impossible to know. As this letter is being written, the pandemic continues to spread and it looks like the peak in the U.S. will not be for several more weeks, at best. While the stock market has rallied the past ten days, it is important to know that most of the best one-day gains in stock market history come during bear markets. It is too early to know if stocks have bottomed, or if this is nothing more than a bear market rally.
Time will tell on this, but I suspect it will get worse before it gets better. Even at its lowest point, the stock market was not cheap relative to earnings, and those earnings are going to plummet for at least the first two quarters of this year.
I have always advised investors to pay attention to the numbers, because they tell you how to invest. The quickness of this economic and market plunge skews the numbers and makes them largely useless. We’ve really never had this type of economic shutdown, so history isn’t much of a guide. We are forced to make decisions and plans based on forecasts of the future that are, at best, problematic and changing nearly every day. Buyers of stocks right now are counting on the virus ending sooner rather than later and that the economic stimulus will keep the recession short and fairly mild. Neither is guaranteed, or even likely. We will be buyers of stocks at some point, but not now. I see nothing that leads me to believe that the potential return relative to the risk is justified at this time.
I expect this recession to be fairly short but very severe. History tells us that recessions caused by a single event tend to be shorter than ones caused by broader economic problems. However, while it is possible, I am not expecting the much talked about “V” recovery, which is a fast drop followed by a fast recovery. I believe that a prolonged economic downturn and a slow choppy recovery is a very real possibility. The longer the pandemic lasts, the more economic damage will be done, and the longer it will take to recover. I have read many estimates on the recovery, but most are not based on facts but only on hopes and speculation.
Due to shelter in place requirements, all three of our offices are closed and we are working remotely. Please do not hesitate to contact us, and rest assured that we are doing all that is possible during these difficult times. This isn’t the first bear market we have been through, and it won’t be the last. Times like these are very scary and it sometimes seems like things will never get better. But this will pass. The list of catastrophes the world has survived takes up more room than this letter allows, but we always recover and come back stronger than before. This time will be no different.
As always, please let us know if you need anything, and stay safe.
Don Edwards, CFA
Wabash Capital, Inc.