No Way Out But Through

First quarter of 2020 has just ended and almost no superlative seems too great to describe these past months. So much happened at such a fast pace, it seems impossible that we’ve come to all this. Recriminations abound about what could have been done earlier to avoid our current fate. Years of analysis and mountains of writing will be devoted to this moment in history.

For my own part, I feel stunned by the scope of it all. The past weeks have been for me an emotional and intellectual tumult in search of context and understanding. My mea culpa is around how I underestimated the magnitude of this crisis: the spread of the virus, the public health prevention response, the economic impact of the global shutdown, and the economic policy response both fiscal and monetary. None of it seemed plausible a few short weeks ago. A brilliant friend of mine calls it a natural disaster, which seems apt. And we all have no choice but to pick our way through the aftermath. So what happens now?

Fear vs Reason
Now the data begins to catch up to the event. We enter a phase where the numbers being collected dominate the discussion, and they mostly look awful. We’re into a world of testing rates, new cases, hot spots, outbreaks, economic contraction, and death toll. All of these are scrutinized to try and figure out where we are on the (probably flattening) curve. And just to be clear, the shape of this curve is really all that matters for now.

I trust that most people in leadership positions and many media outlets are doing their level best to inform and help us prepare. Much is being said about how the worst is still to come since the data measures our recent past not our future, and the prevention measures take time to have impact. It’s critical that we maintain an even level of understanding.

Even still, there is a great deal of reporting out there that appears sourced in emotion and politics rather than reason and judgement. This is understandable, even predictable. But I think it does a disservice to readership/viewership, because it ends up frightening people. I have received many links and attachments from people who’ve been disturbed by what they read in major publications. I think it’s wrong to contribute to the anxiety being broadly experienced by all of us in the general public. We’ve gone from denial, through panic, and now into fatalism.

For the most part, these articles leave me angry because they cover only the first part of the story about the awfulness that has befallen. It’s like the writers have let their monkey brains run loose with their keyboards. But they leave out the harder part of the analysis about how this might resolve. I don’t see many people trying to imagine the messy recovery that might lie before us. This does a disservice to us all because we need, with clarity, to not only evaluate what happened, but also assess what are the likely outcomes – good and bad – from here.

What Might we Anticipate?
No one knows the future, but some outcomes might be more likely than others. What might happen in the near-term that we can we perhaps anticipate?

Bottoming Process. Too often, investors think about the market bottom as an event. It is true that there will be a low point, but it is important to understand that this is a process that we go through, not a single moment when it all turns from bad to good. It might sound trite, but the market will find a bottom when all of the sellers have finally sold. Beneath all the technology and analysis, this is still a fundamentally human enterprise. Despite all the selling in recent weeks, there may be many sellers still out there. For example, it’s probable that there are people who plan to get out as soon as the market recovers a bit; big pension funds need to move large amounts of capital to rebalance according to plan; and there are those who have reached their own emotional limit on a timeline different from the market’s trajectory. The bottom of the market is marked by disillusionment and distrust with the whole enterprise of stocks and investing. This is when the best bargains are found, but it sure won’t feel like it.

Relief Rally. If you look at prior crashes – and there have been many – it is common to see a similar pattern in the bottoming process. What we are currently seeing could be what’s called a relief rally, which is choked off by a new wave of selling. If this is the case, the market may then go down to retest previous lows. This process can even repeat with lesser intensity until the bottom is formed. But remember, this action needs a reason. Sellers need a reason to sell. Situations such as successive outbreaks or election anxiety could cause selling. Then again, if virus treatment and prevention methods are successful, we could see a rally gain steam as the fiscal and monetary stimulus take effect.

Uneven Recovery. Though the economy stopped all at once, we’re unlikely to see a balanced recovery. Different sectors will recover at very different rates. Some companies will go out of business and some will thrive. It is like the tide swept out and we are left looking at a beach littered with both gems and garbage. The trick will be in knowing how to tell these apart. Some will be obvious and some subtle. The strategy of buying an index fund and waiting things out may need to be reconsidered, as indexes might be a very blunt tool for investing into recovery (indexes were year-to-year flat during much of the 1960s and early 1970s). Recessions cause a shakeout in the economy and the economy that emerges will not be the one that sank. New models and approaches will grow. Old models will prove durable or fragile. All of this presents great opportunity and risk for investors. Change is upon us.

Framework for Decision Making
To organize my own thinking, I’ve been working out this decision model below. It’s an attempt to formalize some things I’ve been thinking about for a long time. It tries to characterize the types of decisions made through fear/greed versus reason at different points in the market cycle. Note: the fight/flight decisions are usually ill-advised.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk including loss of principal.