No V Recovery in US; Perspective on the Economy
and Bear Markets
By Victor
Sperandeo with the Curmudgeon
Introduction:
These are certainly interesting and unique times! In this post, Victor shares
his thoughts and opinions on a variety of topics, while the Curmudgeon provides
a historical perspective on previous bear markets, bear market rallies with
supporting tables courtesy of Goldman Sachs and Bloomberg.
Backgrounder (Victor):
Since 2008, the U.S. federal
government and the Federal Reserve Board have been operating under fiscal and
monetary models that are designed to avoid a recession at all costs, e.g. a
trillion dollar budget deficit accompanied by record low unemployment and ultra-loose
monetary policy. The problem with such a model is that it was not designed to
survive an unknown shock, such as a pandemic.
To clearly illustrate this
point, Janet Yellen, Former Chairperson of the U.S. Federal Reserve said (after
reviewing the results of a stress test in 2017):
Would
I say there will never, ever be another financial crisis? Probably that would
be going too far. But I do think we're much safer, and I hope that it will not
be in our lifetimes, and I don't believe it will be.
To be accurate, Ms. Yellen
said financial crisis rather than recession. Yet if the federal government and
the Federal Reserve had not thrown an atom bomb at the coronavirus it would
be a financial crisis, as well as an economic Armageddon.
Unprecedented Fiscal and
Monetary Stimulus (Victor):
To date, the U.S. government
has authorized the spending of $2.25 trillion in stimulus, a.k.a. bailouts
and giveaways, as well as $4 trillion in loans (which are really grants to
corporations on a need basis). That is
in addition to increasing the Federal Reserves balance sheet to perhaps $10
trillion with QE infinity. For sure,
this was only the first few salvos to be fired; there are other multi-trillion-dollar
spending proposals being discussed.
Deflation Ahead (Victor):
Its important to note that
this virus has caused a deflationary problem, which I expect to persist over an
intermediate time period. Although gold
was up 3.6% year-to-date as of March 31st (primarily as a risk off
or perceived safe haven trade), the CRB Commodity Index is now trading
at February 1999 levels! Trading at less
than 1% nominal yield, the 10- and 30-year U.S. treasuries are also discounting
deflation dead ahead.
For years equities have been
the darling of the rich, the government, and the Federal Reserve, while
commodities have been the black sheep of the financial community. Now theyre both in the tank!
Bear Market Intact
(Victor):
This is an equity bear market
in the classic sense, and it likely hasnt ended after 33 days. (See Curmudgeon comments on what type of bear
market it might be and a history of bear market rallies).
What would be typical is for
the popular stock market averages to make an intermediate low in mid-April,
into the poor earnings season and 2nd quarter guidance horror show. Then we
could see a rally of between 33% and 66% of the first leg down, before making
new lows or major bottom later in the year.
However, it is critical to
recognize that past performance is never necessarily indicative of future
results, especially as the current market is far from typical as are the
factors currently influencing it.
Perspective on the U.S.
Economy (Victor):
The 11 year economic
recovery, which has clearly just ended, will be classified to be at least 126
months long by the National
Bureau of Economic Research (NBER). Thats the longest recovery in
U.S. history.
After the virus pandemic
ends, many pundits are talking up a V Bottom type of economic recovery. In my opinion, that talk is very premature
and highly unlikely.
In March 1933, the highest
unemployment rate in U.S. history was recorded at 24.9%. Yet in December 1936 it was still
19.97%! FDR threw the kitchen sink at
the economy. In addition, prohibition ended, and with the passing of the 21st
Amendment in 1933 tens of thousands of bars and restaurants with hundreds of
thousands of new jobs were created, yet in 3Ύ years the unemployment rate
dropped only 5%.
I do not believe the U.S.
economy will experience a V bottom when so many bad experiences are taking
place. Human nature calls for fear and caution to very slowly move back to
normal spending. With 70% of the economy based on the consumer, does anyone
believe that people are going to go back to pre-pandemic spending ways in just
four months? I think not.
With respect to politics,
President Trump is letting his wishes dictate his statements. According to the Wall Street Journal, Washington Post, and NY Times Trump has ignored the advice of his
medical and health experts, which has considerably slowed the U.S. response to
the coronavirus. That will surely have a
negative economic impact.
Curmudgeon on Bear
Markets:
Every bear market has a
unique set of drivers, but throughout history most of them fall into one of
four categories:
·
Structural These are the result of financial bubbles, too much
leverage, credit market dislocations, and other structural imbalances. Examples are the February 2000 to March 2003
and early 2008 to March 2009 downturns, which each produced -50% declines in
popular stock market averages.
·
Cyclical Cyclical bear markets happen more as a function of
the business cycle, when growth leads to inflation, interest rates go up too
fast, the yield curve flattens or inverts, loan activity declines, demand
wanes, the economy is in recession.
·
Event-Driven These bear
markets are triggered by an exogenous event, like an energy crisis, political
instability, war, or in the case of the current bear market, a global pandemic.
·
Secular This type of bear market lasts for at least a decade
and is usually accompanied by one or more intermediate cyclical bull markets.
However, the major trend is one of wealth destruction as the real purchasing
power of stocks decline over many years. Dollar cost averaging doesnt work and time is your enemy for an equity investor that
wants to retain purchasing power (dont we all?).
The most recent secular bear
market was 1966 through 1982, which saw good rallies from December 1974
through 1978 and then again from March 1980 through the summer of 1981. It was a very painful and frustrating
period for the Curmudgeon.
Looking back at data going
back to the 1800s, Table 1. shows the relative magnitude and duration for the
first three types of bear markets:
Table 1. Characteristics of three types of bear
markets:
Source: Goldman Sachs
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Zacks Mitch on the
Markets wrote in an email to the
Curmudgeon:
Its
important to acknowledge that there has not been an event-driven bear market in
history that was triggered by a virus/disease outbreak. I think its important
to hold out the possibility that this event-driven bear could morph into a
structural (or even secular) bear market if the crisis is not contained by,
say, summer. In the meantime, however, I think the sheer size and speed of
fiscal ($2 trillion legislation) and monetary (virtually infinite liquidity)
stimulus should help keep this bear market in the event-driven category for a
few months.
Curmudgeon on Bear Market
Rallies:
Since the end of 1927, the
index that ultimately became the S&P 500 has experienced 14 separate bear
markets, according to Bloomberg calculations that define them as beginning any
time the index closes more than 20% below a record peak. Assuming a bear market
continues until the index either doubles from a post-peak low or climbs
above its pre-bear market high, the average bear market duration was 641
days.
Within those periods, the
S&P 500 has rallied more than 15% on 20 separate occasions (see Table 2.
below) before retracing those gains. Those advances lasted about 78 days each.
But even some of the retracements were marked with up moves in the market,
underscoring how hard it is to determine the MAJOR TREND in a typical bear
market.
Table 2. S&P 500 Advances of over 15% during Major
Bear Markets:
Source: Bloomberg
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Conclusions (Curmudgeon
and Victor agree):
No one knows how long this
bear market will last. It all depends on
how effective the world is in containing the coronavirus and getting people
back to work. Therefore, dont believe
any of the forecasts you might read or hear about, especially the so called V
shaped economic bottom and recovery.
No end quotes today (weve
said enough already)!
Good luck, stay safe and healthy. Till next time
.
The Curmudgeon
ajwdct@gmail.com
Follow
the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been
involved in financial markets since 1968 (yes, he cut his teeth on the
1968-1974 bear market), became an SEC Registered Investment Advisor in 1995,
and received the Chartered Financial Analyst designation from AIMR (now CFA
Institute) in 1996. He managed hedged equity and alternative
(non-correlated) investment accounts for clients from 1992-2005.
Victor
Sperandeo is a historian, economist and financial innovator who
has re-invented himself and the companies he's owned (since 1971) to profit in
the ever changing and arcane world of markets, economies and government
policies. Victor started his Wall Street
career in 1966 and began trading for a living in 1968. As President and CEO of
Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and
development platform, which is used to create innovative solutions for
different futures markets, risk parameters and other factors.
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