After listening to Governor Newsom’s “stay-in-place” decree last night, we had a lengthy discussion about the impact of a total lock down on California, the market and our expectations for it. During that discussion, we talked about the emotions elicited by both market gains and market selloffs.
A key observation was that it easy to buy into a jubilant market, but it can be difficult to remain invested during a significant market draw-down. Below is a chart of the Dow Jones Industrial Average from January 1, 1996 through March 19, 2020. Between January, 1996 and December 1999, the Dow Jones Industrial Average was up 123% (orange line). As it climbed, so did the volume of trading (purple), indicating more money flowed into that market as it continued to perform well. The more money that was made in the stock market, the more people wanted to invest in the market. During this period, as money poured into the market, the Dow’s volume increased 273%. But then, from January, 2000 through October, 2002 the Dow proceeded to lose 38% of its value. During that period, as money poured out of the market, you can see that trading volume gradually began to fall.
Then, as the market began to climb again from late 2002 through early 2008, we saw steady increases in volume again. However, the Financial Recession of 2008 (when the market lost more than 52% from peak to trough) caused a steady decline in the Dow’s volume through the beginning of 2017. Then, in 2017 (after the Dow had produced a price return of more than 177%) there was again a sudden increase in the Dow’s trading volume.
This behavior of pouring into a “jubilant” market and jumping out of a falling market is an emotional response, and it can be disastrous to investment returns. We believe that looking at the market objectively and understanding what is priced in can help investors make more prudent investment decisions. For example, in March of 2000, large cap industrial firms were priced to deliver 22% annual sales growth; the problem is that these firms typically only delivered between 4% and 6% sales growth. Then, during the lows of the 2008 Financial Crisis, stocks were pricing in a -15% sales growth. As stocks demonstrated that they could deliver positive growth (not a 15% drop in sales), a new bull market was born.
Today, the market is pricing in 0% sales growth over the next 5 years, which seems harsh considering the 20%-30% growth they have typically delivered over the last 5 years. This is a confidence crisis, similar to what we experienced after 9/11. And with all the uncertainty surrounding the Coronavirus, we understand the confidence crisis. How will firms operating in California and New York meet payroll with California and New York on lock down? How many other states will implement a lock down? How many jobs will be lost as a result of these lock down measures, and how long will people have to stay in lock down? What will be the human toll of Covid 19, and what will that do to the markets and economy? The truth is that no one yet knows, and because no one knows, all of the planning being done is for a “worst case scenario.” However, as medical policy catches up with the Coronavirus, confidence will return and society will begin to return to business as usual.
We see promising reports out of China that may serve as a model for the rest of the world. We know that many are inclined to disbelieve the data out of China, however, dock activity at the Los Angeles port seems to support what the Chinese are telling us. Further, the CEO of FedEx shared information in an interview that also supported what the Chinese are telling us. His comments give a glimmer of hope. We encourage you to watch his comments at the link below:
https://www.youtube.com/watch?v=70A2Px_5m78
Additionally, there are treatments in the US and in other countries that are showing promise. If the additional testing underway continues to support these results, we will see more of these treatments implemented, and they will dramatically change the expected outcome for Coronavirus. Regeneron CEO Leonard Schleifer said in an interview with Barron’s on March 17, 2020 that he is aware of current drug trials with Gilead Science’s Remdesivir, which is an anti-viral that was tried with Ebola that interferes with the functioning of the virus. He also shared that his company also has a drug, Kevzara that was developed for rheumatoid arthritis to reduce inflammation, which may be effective at reducing the impact of Covid 19 in human lungs. Also, Roche Holding has a drug, Actemra, which blocks the function of the interlukin-6 receptor and has had impressive, albeit uncontrolled, data. Twenty-one patients were treated with it, and all of them did very well. This drug has also been tried in Italy with reportedly good results. If the studies on these drugs are enrolled quickly, we should know within a few weeks of treating patients how they are doing.
Our point is that there are a lot very bright people working very hard on this problem, and an unprecedented number of resources are being made available to address Covid 19. Covid 19 is getting a lot of press now, but just as the fear of the Tech Bubble, 9/11, the Financial Crisis of 2008, and H1N1 were erased, so to will be the fear of Covid 19, and when it is, the markets will end much higher than they are now.
Please call us or email us if we can be of any assistance.
Sincerely,
Fortem Financial
www.fortemfin.com
(760) 206-8500
