In this installment of what has become a weekly message, we’ll focus on some recent history of the markets and how it might help us in the current environment. History can teach us a great deal, and in times of market anxiety, I find it valuable to look to the past for guidance. Most of us are familiar with the quote “Those who cannot learn from history are doomed to repeat it.” Hopefully, this message will help you to make more informed choices about your investments.
BY LOOKING FORWARD WITH AN UNDERSTANDING OF THE PAST, WE CAN BETTER MANAGE RISK AND IDENTIFY OPPORTUNITIES
You have probably heard it said that the market is a “forward-looking mechanism” or “discounting mechanism.” Many individual investors I speak with claim to understand this, but their investment behavior indicates otherwise. In essence, that phrase simply means that the market as a whole is more interested in what the future holds than in what happened in the past, or even what is happening right now. There is a well-known body of research that suggests that at any point in time, current market prices reflect all currently known information. Conversely, the study of the economy mostly looks at historical data (typically from the last one to three months) to measure the health of the economy. Certainly, there are interpretations everywhere that attempt to project current and historical data to the future. In fact, we as investors regularly use the knowledge gained from past economic events to help guide us through contemporary challenges. However, without the context of how prior changes to the economy and economic cycle unfolded, and how the markets behaved in those same periods, investors are often led to making poor decisions.
IF YOU CONTINUALLY STARE AT THE GROUND, THE SUN WILL NEVER SHINE ON YOUR FACE
First, it’s important to note that despite the innumerable negative news reports, books, newsletters, and individual investors explaining their doubts about the future of the economy or the markets over time, the markets have always endured and recovered. We have challenges along the way, and there are structural issues that emerge from time to time, but the overall strength of our economic system has brought us prosperity and opportunity unmatched in any other time or society. For most of us, this is not the first market correction we’ve faced, and with any luck, it won’t be the last. Every one of those markets of the past has ultimately recovered and gone on to higher highs. We think that record is more than likely to continue, so I offer the following…
THE ECONOMY IS NOT THE MARKET
I could give you a list of pithy quotes from legendary investors on this, but I’d rather spend time illustrating the point in a way that brings a better understanding of this than a simple quote can provide.
Early in my career, I worked with a Commodity Trading Advisory firm that managed pooled funds of commodity futures. The primary fund manager that I worked directly for was a particularly bright and studious man, holding several advance degrees and decades of experience in the industry, working for decades with one of the largest oil companies in the world. He was adamant about the observation that “the economy is not the market, and the market is not the economy.” To some that may appear to be a very vague distinction, but it’s an essential one for all investors to be mindful of. One of the most common mistakes I have observed individual investors make is conflating the two. This mistaken notion leads some investors to assume that they can “trade the headlines” and either capitalize on or avoid negative effects by taking action in their portfolio. To be sure, there are times when headlines are prospective, and longer-term impacts of events are sometimes unknown. But, given today’s near-instantaneous flow of information, by and large, any news one sees “in the headlines” the day after an event is ancient history as it pertains to the markets.
To put a finer point on this idea, the economy and markets are interrelated but do not move in lockstep. Markets routinely adjust in anticipation of economic change, as full-time market participants, analysts, and strategists digest financial and economic forecasts, to project trends using sophisticated modeling and analyze possible future asset valuations. All this leads to trading activity that reflects the collective assessment of what the future holds for the economy and corporate financials.
That said, unforeseen events happen, and markets sell off very quickly, as they did in early March. Unfortunately, “going to cash” based on a negative headline is commonly done too late, as typically the market selloff has already occurred. Often at this point, shrewd investors have already shifted their scrutiny to what opportunities may exist, as markets have a tradition of over-shooting to both the downside and upside in tumultuous times.
SOUND BITE INVESTING IS NOT A STRATEGY. LEARN THE LESSONS OF HISTORY.
We have seen many instances over the years of individual investors “going to cash” as a defense against negative headlines they are seeing in the media. In addition to the fact that this knee jerk reaction is not truly a strategy, it opens up the need for another decision that is often more difficult than the reactionary defense itself. When do you buy back? In the history of corrections and bear markets, those markets have consistently begun their recovery well before the worst of the economic news was released, making the decision of when to buy back in is vastly more difficult.
By way of example, note that the lowest point for the S&P 500 during the Great Recession of 2008-2009 occurred on March 9, 2009. It was nearly two months later when the official report was released showing that the economy had contracted in the first quarter by 3.92%, making it the worst quarter for economic growth through that particular recession. Meanwhile, from March 9, 2009, to the 30th of April, the S&P 500 was up over 27.5%. In fact, the great recession didn’t end until the fourth quarter of 2009 – fully eight months later, and that positive GDP report (up 0.18%) was not released until the end of January 2010. By that time, the S&P 500 was up over 57.0% from the previous March 9 low. The market had run up over 57.0% in that heart of the recession!
“FEAR CANNOT BE TRUSTED. IT EXAGERATES EVERYTHING. IT IS BOTH TRECHEROUS AND DISHONEST.” – David Gemmell, Fall of Kings
Clearly, for those investors that were trading the headlines, the “easy” decision was to go to cash in early 2009 when the news was at its worst. In fact, several post-mortem analyses of individual investor behavior at the time revealed that many fearful investors did just that. But fear rarely leads to rational investment decisions. It would have been particularly difficult for those investors to re-enter the markets in 2009 in the face of such discouraging economic headlines. On the other hand, those patient investors that either maintained their risk-based asset allocations or were looking through the recession toward the recovery and putting money into the market came out in much better financial shape.
Based on history, I would expect this particular market to begin its recovery well before the worst of the economic news is released.
PROPER INVESTING CALLS FOR KNOWLEDGE, PERSPECTIVE, AND PATIENCE. THE ABSENCE OF ANY OF THESE THREE WILL LEAD TO LOSS.
In my estimation, there is less risk in the stock market at this moment in early April than there was on January 1. I admit, that view is with the benefit of hindsight. On January 1, nobody foresaw the outbreak of a global pandemic. Acting under the belief that we were in the late stage of the economic cycle, we at Atlas had been shifting to a more defensive posture by reducing our exposures to equities, and credit risk on the bond side, for several months. Thankfully, these moves helped to lessen some of the downside capture in this market. That said, it is history, and we are now looking forward.
While I am not calling a market bottom here, things recently have begun to look somewhat better in the markets. Since March 23, we have seen credit spreads (the additional yield a bond investor receives over a U.S. Treasury bond in exchange for taking on credit risk) narrow. This is an indication that bond investors see less relative risk in the future than they had in the past. We are also seeing the VIX (Chicago Board of Exchange measure of expected equity market volatility) coming down. On the days over the last couple of weeks that have had rallies, we’re seeing improved breadth or a wider range of individual stocks advancing in the market. Lastly, negative market sentiment has reached extreme levels. As individuals reach such pessimism, it can indicate the selling impulse may have reached its peak, and there may be less potential downside pressure on the market. To experienced market participants, this can be a rather positive sign.
My message this week is this: while individual investors are absorbing the torrent of negative headlines, we at Atlas are taking note, but also looking beyond them. As I said earlier, the markets will recover well before the last of the negative news is released. The economy is not the market, and the market is not the economy. For patient investors that are properly positioned, there will be opportunities. We need to have the knowledge, perspective and patience to be able to recognize them when they develop.
Take care of yourselves in this time of health risks, and stay safe. We at Atlas will work hard to do the same with your investments.
John C. Ogle
Chief Investment Officer
Private Wealth Management
 Bureau of Economic Analysis, Interactive Data – bea.gov/data/gdp/gross-domestic-product