This past week was a reminder that volatility lurks in the market and that the days of outsized up and down returns have not yet been extinguished. On Thursday, June 11th, the S&P 500 fell nearly 6% as investors began to worry that the path to economic recovery may not be as linear as some expect. The market has frankly rallied harder and quicker than we and many have expected. The current valuation bakes in a V-shaped recovery. While possible, it seems less probable in our view.
Behaviorally things feel better today than they did in March or April. Economies are slowly reopening as social distancing measures are easing. Economic data is indicating that we may be past the nadir of the downturn. Investors, however, should anchor themselves to the notion that the economic impact from the pandemic is going to be longer than a quarter or two and will not end when social distancing measures conclude. Furthermore, the economic consequences are going to have a more profound impact on some businesses than others. Lastly, there will be businesses that reopen, but over time the financial challenges to remain open will be an ongoing concern. These consequences of the pandemic are going to take some time to sort through, and as such, we think the right mind frame is to think in quarters or even a year (or two) rather than weeks or months.
As it relates to the markets wild ride over the past few months, it’s important to remind ourselves that past bear markets rarely are V-shaped and tend to take time to fully work through. In the tech bubble, the market peaked in March of 2000, but the downturn didn’t really start until September of that year. In 2008, Bear Stearns failed in March, with the market retracing the downturn, before taking another leg down in September. Whether we experience more downside in the coming weeks or not, it’s important to keep in context the ramifications of COVID-19 are likely to take 1-2 years to work through.
Given the expectation that we are likely to have a more prolonged economic recovery, it seems more probable to us that heightened levels of volatility will remain for some time. We have never experienced a pandemic that shut down the economy before. Not only is this a new experience for all investors, but no one knows for certain the cadence from here. This will induce volatility, both to the upside and the downside, and it seems logical this will persist until there is less dispersion around the potential range of outcomes for the virus and the economy.
Keep in mind, past crisis and downturns occurred because there was a great deal of uncertainty. Markets don’t like uncertainty, which is why it is punished. While we can’t prescribe exactly the outcome, we will ultimately come out of this pandemic induced malaise. Markets will recover and benefit from economic growth.
After this past week reminded all of us that the downturns can return, we would offer the following guidance to investors: