Market pullbacks have been and will continue to be part of the investment cycle, and the often unexpected or unpredictable events that trigger these episodes can catch market forecasters by surprise. In addition, the welcome return to an upward trending market is clear only with the benefit of hindsight. Consensus opinion pointed to modest gains in the benchmark S&P 500 index after 2019’s historically high returns. Market analysts could not have anticipated the tragic worldwide health impact and resulting economic consequences of the Covid-19 illness or the simultaneous onset of an oil price conflict between Saudi Arabia and Russia. These factors hit the financial markets like a proverbial freight train and the S&P 500 fell 20% into bear market territory in record time – just 22 days after hitting an all-time high on February 19th. The financial markets regularly shrug off bad news as temporary, but markets and investors find uncertainty much more challenging than actual bad news. The Covid-19 illness has created a great deal of uncertainty first and foremost from a human perspective and secondarily from an economic and business perspective.
The U.S. economy started 2020 on solid footing, buoyed by three Fed rate cuts and the resulting lower long-term interest rates. Hiring remained strong and unemployment clung to 50-year lows, creating a positive backdrop for consumer spending. Lower mortgage rates looked to be boosting residential construction. Activity remained fairly robust until news of the spreading Covid-19 illness began to dampen consumer and business confidence in late February and early March. Preventive health measures began impacting the economy in mid-March, and it’s realistic to expect 1st quarter data to show very muted or potentially negative economic growth. Forecasts point to economic activity shrinking during the 2nd quarter as the full Covid-19 impact hits before growth likely reaccelerates later in 2020. While health concerns occupy headlines and impact economic growth near-term, economic momentum heading into this episode could be a tailwind once those concerns can ease.
The initial market pullback spared no sector, with the sharp price declines broad-based and indiscriminate. There is increasing recognition of and beginning price recovery in the sectors and companies that are providing essential products and services, demand for which is strong and growing. Consumer staple companies are benefitting from households stocking up on necessary goods for an extended stay at home. There’s strong demand for technology products and services that facilitate connectivity to allow households to work and school from home and stay in touch with friends and family from a distance. Those same technologies help bring entertainment options home. Utility output seems to be one constant in calm and less certain times. Healthcare companies are on the front lines of battling Covid-19 and researching appropriate treatments and potential vaccines. Lower interest rates present a challenge for banks, but healthy balance sheets can help the industry provide loans that eventually spur renewed economic growth. Energy lagged before the oil price war and decreased demand due to Covid-19 hampering economic activity will provide additional headwinds. It’s difficult to forecast near-term earnings due to the unprecedented Covid-19 impact, but longer-term prospects should drive valuations once the current uncertainty subsides.
The Fed has dramatically lowered rates to boost economic growth once health isn’t the foremost concern. They have taken additional policy steps to aid businesses and the financial system while growth is unavoidably subdued. Congress has acted in bipartisan fashion to assist consumers and businesses. Historically the U.S. has proved resilient in reacting to and recovering from all manner of challenges. Challenge has tended to unite and empower the nation. It’s as difficult to foresee a bear market’s end as the onset, and some of the best returns occur in the initial move up from the lows. Missing those “big” days can meaningfully detract from long-term returns. In spite of near-term turbulence, strong businesses remain positioned for long-term success. Much of the selling that’s driven the market to the recent lows has been based on fear, not fundamentals, meaning select, high quality stocks are on sale at substantially discounted prices. Sticking with a long-term plan will ensure investors can benefit when the cloud of uncertainty clears and fundamentals and long-term prospects again drive market prices.