BY THOMAS FRISBIE, CFA
For the sake of speed and efficiency, this blog post is available to clients and other people we consider interested in our work. Therefore, the comments within or additional thoughts might have already been shared or discussed with you personally, but this short piece is designed to touch all bases and explain to clients some thinking concerning the remarkable behavior of the stock market over the past week.
What we experienced last week was what we in the business call a “waterfall decline,” and these are actually rather common in the long history of the stock market. They are almost always triggered by a surprising development that quickly and radically changes the stock market’s rosy outlook. In this particular case, the change was from the assumption that the coronavirus was a “China or Asia problem” to the assumption that the coronavirus would go global, and that embargoes on the movement of people, goods and services would bring business profit growth to a screeching halt. Waterfall declines almost always occur after investors have enjoyed a long bull market run and have large profits but low cash reserves with which to buy stocks on the way down.
Waterfall declines normally stop when we get technical readings that suggest, in common language, that investors are freaking out and selling their stocks by the box load. We almost got those readings Thursday, and we did get those readings at noon on Friday, after which the market rallied more than 2% off the lows of Friday afternoon. THE NORMAL BEHAVIOR OF THE STOCK MARKET WOULD NOW BE A BOUNCE HIGHER OF A FEW PERCENTAGE POINTS, ALBEIT ON CRAZY VOLATILITY UP AND DOWN, AND THEN A REASSESSMENT OF THE PREDOMINANT ISSUE (GLOBAL EFFECTS OF CORONAVIRUS) IN A WEEK OR TWO.
The whole process should make a chart of the stock market look like a lower case “h”— a decline straight down, then a bounce that recovers part of the decline, then a second decline to go back to Friday’s lows. After that, the market either moves sideways in preparation for another bull market or continues down as coronavirus fears become even greater. Every day in the market is uncertain for all of us, but we have some tools that should help us make a decently informed decision on which way it will likely go at that point.
The basic drivers of a healthy stock market are still intact, the most important of which are cheap and abundant funds that are available to be borrowed from banks or the bond market. With the exception of a few already-stressed industries such as oil and gas production, business conditions are favorable. Therefore, based upon what we can see today, we do not expect the present decline to become a major bear market. We also expect the stocks representing businesses that are strongly positioned to thrive even in a more muted economy to begin to work, while the stocks of businesses that have serious issues (such as airlines or many retailers currently) may continue to struggle.
We hope this has been helpful. Our staff can discuss the market in much more detail over the phone or in person. Thank you for being our client or an ally in our work.
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed.