The Market: This Is What Panic Feels Like

This week in March will be one everyone remembers.   Specifically for me this pandemic will be up there with my adult life events with sitting in a college lecture room and hearing about and watching the news on September 11th, touring the floor of the NYSE in March of 2003 (the day the conflict started with Iraq), and professionally living through the failure of Lehman Brothers and numerous large banks while working in banking.

The human impact of this should not be understated or minimized.  It is not my purpose to do that and I am in no way qualified to make comments on that.  These thoughts are primarily related to the markets and financial impact, as the activity that happened this past week I’ve only seen one other time in my investing life and two times in my lifetime.  

So what happened in the markets?

Monday, Tuesday, and Wednesday looked like fear, greed, fear.  Thursday was outright panic. There is no other way to describe it.  Lets recap some of the history from Thursday:

Dow:  (9.99%) – This is the 4th worst day in history and the worst single day in the market since the 1987 crash.   

Bond ETFs (-4% to -5.66%) – Bonds finally broke.  Investors/portfolios wanted cash and nothing but cash and short term US Treasuries.

The Utility Index broke and were down over 10% in a day.  These are the safety stocks.

The Volatility Index reached 73, which is the second highest on record (the peak being 80 when Lehman Brothers failed).

The Fear & Greed Index made it all the way down to 2.

This was already the fastest bear market in history (from peak to bottom, not as sharp as the 1987 one day drop if we use a point to point in time). 

Each time we get to the point of panic in the market, it’s the same but different.   In the early 2000s we had a horrific terrorist attack in the middle of a market decline.  In 2008 we had a rash of bank failures and a bank run after a one year slow decline in the market.  Now we get hit with an immediate and unexpected economic slowdown due to COVID-19. We are now in a recession and just saw the panic sell off on Thursday.   

What do I think happens next?

Friday provided a recovery of most of Thursday’s losses, but this is also a product of high volatility.  I have absolutely no idea what the overall market is going to do. It may drop another 10% or it may go up another 10%, but Thursday is how the resolution process starts.   The panic in the market hopefully hit its peak, but there are lingering issues that will likely make for a bumpy ride going forward.  

Here are my thoughts:

• There may be a quick “back to normal” on main street.   We all could be back to our normal routines in thirty or forty five days.  Unfortunately that doesn’t guarantee the market will return back that quickly or there isn’t a ripple effect.  Nobody knows how big or widespread this pandemic will be and the subsequent fallout.

• There is a debt “problem”.   The COVID virus and shutdown was just the spark that will set off this problem.  Ten years of a good economy and strong banking system led to competition for loans.  Eventually this meant more dollars loaned, lower pricing, and looser terms. This means many companies were leveraged to perfection and providers of debt weren’t being paid enough for the risk.   What happens when there’s a disruption in a business leveraged to perfection? The business, the banks, the bond holders, and equity investors are all going to share in the pain. This may or may not be priced into the overall market, but the bad news from this is going to trickle out over time.  

• There will also be consumer problem.   The same debt problems related to companies also apply to consumers.   The average new car loan is $32,480 with a $550/mo payment over eighty four months.  Housing prices reached new highs and low down payment loans with private mortgage insurance are once again popular.  This is going to be tough when income is disrupted and people can’t sell the underlying car or home to make the payment go away.  There will be governmental and creditor responses, but these usually lag and won’t help everyone. This is going to trickle through the economy with car sales and housing taking a hit.

• Corporations will have issues running out of cash and be forced to raise money.  In times of panic, this could mean extreme measures to come up with cash, including selling assets at steep discounts, borrowing money at higher rates, issuing shares at discounted prices, or agreeing to be acquired at a discount.  This applies to both private companies and public companies and the economic disruption from this hurts. Lower capital spending is inevitable and so are the layoffs that follow lower spending.  

Are there investment opportunities?  Absolutely.  

• Index Funds:  The Case Shiller Index is priced at 25 times earnings at the time of writing. This is about the middle of the range of pricing since the mid 1990s.  (I think this is the best time period to look at because the mid 1990s is when the market participation rate reached its current range).   This means the market isn’t overly cheap or overly expensive at these levels, especially since there will be a disruption in earnings for 2020.   This is great news for investors with decades ahead but is a little more sobering for those invested in index funds and expecting an immediate rebound to January levels.   The Shiller PE probably falls further, but I have no clue if it’ll be solely because of lower earnings, or if prices still have a ways to go down.

• While the index as a whole may have come down to a fair price, there are companies out there discounted as if they will have to firesale.   Entire industries are being sold off, even if certain companies in that industry have little debt and months/years worth of operating expenses in cash.  If you have interest in analyzing this and can accurately identify the survivors, you can earn outsized returns in this market.

• There are also companies that will be acquirers.  The easiest purchase to make right now is Berkshire Hathaway.  The company has more than $100mil in cash on their balance sheet and has historically gets “loan shark” style terms when a company needs to raise cash. Berkshire also gets a premium for the implied endorsement of Buffet & Munger when it makes the investment. You can participate in this through owning Berkshire.

One Final Thought:

I rarely wade into politics, because my thoughts are guaranteed to offend both sides, but we are staring at a pandemic led recession and I’m going to touch on this a little:  I hope the United States can move back to electing experienced leaders that will lead. This isn’t just about the current President’s bad twitter habits, insulting the independent Federal Reserve, or the fumbled national addresses this week.  In the last twelve years we’ve now had one party cram down an overhaul to how healthcare is paid for/provided and the other party cram down an overhaul to how government is funded. These were done with zero support from the opposing party representing roughly half of the country and are now political footballs.   Any discussion about either is immediately called “Obamacare” and “Trump Tax Cut” by the other side and campaigned against. Now the country has to deal with a pandemic driven recession which is going to place immense stress on both the healthcare system and government revenue*. These are real issues.

Perhaps the long term positive outcome from this is we can move back to electing people with leadership experience.  Specifically I’d like to see future Presidents run a state as a governor before they are in charge of all fifty states.   The country had a nice run of state governors moving on to be elected as President and it would be nice to see the voters once again place value on experience.  

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*The most concerning part to me is these two issues are intimately tied together since there’s an growing gap between revenue and expenses from Medicare, a program signed 54 years ago and was supposed to be self funding through payroll taxes.  Now roughly half of every dollar spent is borrowed (or “comes from general revenue”, a euphemism for borrowed) and nobody is talking about it.   In the last fiscal year, the United States had roughly 3% economic growth, but had less than 1% growth in tax receipts and 8% growth in expenditures.  One side sits there and blames “wasteful government spending” for the deficit while the other side blames “tax cuts for rich people”. The reality is more than half the deficit comes from a 54 year old program regardless of who is in office today and the country can’t endure government spending growing at a rate faster than the economy and having tax revenue that grows slower than the rate of the economy