With the major indexes now in a bear market as the coronavirus has developed into a “Black Swan” event—a major unforeseen risk—the question on most people’s minds is whether markets have hit the bottom or have further to fall. Though it is too soon to tell whether we have reached an actual bottom, there are some important observations about market rebounds and investor psychology that are very helpful.
Identifying the exact market bottom is extremely difficult, and investors have range of tools such as analyzing macroeconomic data or valuing stocks and other assets. One common approach, however, which is tempting but definitely does not work, is to try to gauge the sentiment of investors through the media. During times of crisis there is a tendency in the media and in investors generally to become fixated on the negative. Once an apocalyptic narrative takes hold, it is hard for people to break out of it, even when things have improved.
This is what’s known as status quo bias or recency bias. When the market has been going up for a while, we have trouble imagining anything different. Similarly, when the market has crashed people become locked in this negative mindset.
In 2009 we saw a clear example of this. The market bottomed on March 10. If you read the news on that day or in the weeks before or after, there was little indication of optimism. The negative narrative had been locked in. Below are just a few examples among the countless negative articles published as the market rebounded in the longest bull market in history:
“Housing Prices in 20 U.S. Cities Fall a Record 18.5%,” Bloomberg, February 24, 2009
“Stocks fall to lowest level since 1997 as Dow drops below 6,800,” USA TODAY, March 2, 2009
“663,000 Jobs Lost in March; Total Tops 5 Million,” The New York Times, April 3, 2009
“George Soros says US banks ‘basically insolvent‘,” Reuters, April 6, 2009
“Warren Buffett: U.S. Economy In “Shambles” No Signs of Recovery Yet,” CNBC, June 24, 2009
For many months and even years after the rebound began, there were predictions from financial pundits of a so-called “double-dip” crash or recession, even as corporate earnings rebounded and economic conditions improved.
Another important point to keep in mind when thinking about a rebound is the significant lag time that is built into stock prices. Let’s take a step back for a second and think about what exactly stock prices mean. In theory a stock price represents an estimate of the future cash flows of a company discounted back to the present value. The recent plunge in stock prices is based on a hypothetical recession and decrease in corporate earnings that is now predicted. If that recession plays out as expected that does not mean that stocks will necessarily keep plunging. The recession is already significantly priced into valuations at the current level. A recession is assumed; it is the new baseline. The risk is that the recession could be worse than the one that is currently expected.
We need to expect a significant amount of bad news coming and know that it is not the headlines that are going to drive stock prices.
Now that the negative bias has taken hold, we all need to work hard not to screen out the positive news that is emerging and potentially offsetting some the scary events. Here are a few developments that we find very encouraging right now:
1) There are several experimental vaccines being developed around the world and some are now entering clinical trials. (link)
2) China’s number of new cases has been drastically reduced. (link)
3) There are a number of drugs and other treatments that have been shown to be effective. (link, link)
4) Several labs in the U.S. including Cleveland’s MetroHealth Medical Center are developing new tests that work in as little as two hours. (link)
5) There has been a dramatic drop in new cases in South Korea. (link)
6) More economic stimulus is coming. We are encouraged that a government stimulus package to support the American worker and their families will be announced this week; possibly as soon as today. (link)
These and many other positive stories are important data points that should not be discounted as we are confronted with the barrage of negative headlines. Though it is important to stay informed, we recommend that you try to avoid spending too much time reading negative stories on news sites or social media.
If you would like to hear our latest thinking or have any particular questions, please do not hesitate to reach out. Lake Street is fully operational and monitoring events and client portfolios extremely closely. Stay tuned for more updates and please stay safe.
Presented by the Investment Committee of Lake Street, an SEC Registered Investment Adviser.
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.