Are We There Yet?

– by Chip Sawyer, CFA , Chief Investment Officer

It’s about an hour’s drive from my parents’ place in Maryland back home. The weekend before last, my five-year-old daughter fell asleep before we had even left their Worton driveway. When she woke up, as we pulled safely into our driveway here in Wilmington, she looked around incredulously and asked me, “Daddy, are we there yet?”

My nine-year-old was awake for the entire trip but was so engrossed in the video on her tablet she might as well have been asleep. Neither one of them had noticed the rain, which we drove through for fifty-five of the sixty-minute trip. I remember similar experiences when I was a kid. Family road trips always went much faster when I was sleeping, rather than fighting with my two older sisters.

An investor who fell asleep as she was leaving that Maryland driveway on February 24 and who happened to wake up today in Wilmington, would look around just as incredulously. She, too, would have missed the rain. Well, that’s not entirely accurate. She would have missed a Category 5 hurricane followed by a blistering heatwave.

The S&P 500 Roller Coaster

The S&P 500 Index is currently trading at around 3,200. Since the end of February, the index has traveled more than 2,200 points, first down, then back up. First, it fell more than 1,200 points from its high in February to its low in March. That was the fastest 30% decline in market history. It took just twenty-two days. Then what do you know? It turned around and rose more than 1,000 points, bringing it to its current level today. The rise included a 20% advance in just 12 days, which was the fastest advance since 2008.

With a June unemployment rate of 11.1%, representing 17.8 million Americans out of work, and with the country currently experiencing a worrying rise in COVID-19 cases, most investors are looking at the markets today with bewilderment. It’s the same look my daughters showed when the younger one awoke from her nap, or the older one looked up from her tablet.

Policy Response and Market Construction Help Explain the Astonishing Recovery

It’s always easier to explain things after they’ve happened, but there are several reasons for the market’s astonishing recovery. The most important explanations fall under two categories: policy response and market construction.

As to the first point, the current recession was caused by a global pandemic, rather than by the excesses that accompany the typical economic cycles of markets — too much technology in 2000 and too much housing in 2008. There isn’t any moral hazard to worry about right now with the issuance of monetary relief. Accordingly, the policy response from the Federal Reserve and Washington has been MUCH more generous than in prior periods.

In 2008, the Federal Reserve responded to the financial crisis by expanding its balance sheet by about $1.3 trillion from March of 2008, when Bear Stearns collapsed, through December of 2008. In comparison, it took the Federal Reserve a mere three months to expand its balance sheet by $3 trillion from March of this year until June. That’s almost three times the response in one-third of the time.

It’s always easier to explain things after they’ve happened, but there are several reasons for the market’s astonishing recovery. The most important explanations fall under two categories: policy response and market construction.

At the end of this March, the credit markets were shaking with fears of massive bankruptcies. As a consequence, the Fed also announced they would begin buying corporate debt for the first time in history. Their response put the majority of those fears to sleep.

Congress has had just as aggressive a response. They provided about $900 billion in stimulus during the 2008 Financial Crisis, but only about $700 billion of that was spent over the following three years. In response to the current pandemic, Congress passed legislation totaling about $3 trillion. This legislation included $500 billion for the Paycheck Protection Program, $2.3 trillion for the CARES Act, and about $200 billion for the Families First Coronavirus Response Act. This fiscal response was so significant that the nation’s personal income in April increased by 10.5% in the middle of this global pandemic!

Here’s the second point: While professional investors are familiar with the outsized influence a handful of companies and sectors have on the performance of market indexes, the casual investor might not be. Even before the current crisis, a major theme was developing in the economy—the switch from brick and mortar to online and mobile. This trend has reached a real tipping point. And it went into hyperdrive over the past four months, as everything from grocery store trips to schoolwork moved online. We’re having virtual Zoom birthday parties for our kids, followed a few hours later by take-out cocktails for their parents. Heck, the NBA’s even going to play basketball in a bubble in Orlando with no fans in the stands . . . which we’ll stream, of course!

So while the casual investor might be confused by the market’s remarkable recovery, a closer look at market construction explains the reason. The companies that benefit from more online activity or virus research — Amazon, and most of the technology and healthcare sectors — are making new highs, while economically sensitive value stocks are still struggling. Amazon, Facebook, and Alphabet, combined with the technology and healthcare sectors, make up more than 50% of the S&P 500. (That bears repeating). These are the forces driving the market higher.

COVID-19 Cases and Unemployment Continue to Drive Concerns

As always, there are still plenty of concerns. There were over 73,000 new cases of COVID-19 in the U.S. on July 16. A new record. There are almost 18 million unemployed Americans. There’s massive social unrest in the country. Minneapolis, Portland, Seattle. There is an upcoming presidential election whose result, regardless of which party wins, will only make an increasingly divided country even more polarized. Predicting the long-term damage to the global economy and the speed with which it will recover seems an impossible task. The volatility we’ve seen in the market is likely to continue.

So, what’s an investor to do? Go to sleep and let us drive.

Every day is a day we get closer to a vaccine. Multiple companies are working on vaccines. Most recently, we heard that a vaccine developed by Astra Zeneca and Oxford University had produced a promising immune response in a large, early-stage human trial. We’re getting much better at managing the virus as the mortality rate in hospitals continues to decline. Daily deaths from COVID-19 spiked at 2,701 on May 6, but fell to 512 on July 19, notwithstanding a 250% increase in the number of cases — from 24,805 to 63,591 on those same two days.

You may remember that Dad wrote of the dichotomy between the present and the future, between markets and the economy, in a recent article posted to our website he called, “Now Showing in Theater Number One . . .” The market is a forward-looking indicator and is becoming more interested in 2021 earnings than it is concerned with 2020 results. Many of the companies held in Westover portfolios are beneficiaries of those accelerating trends we described above. You don’t realize it when you’re a kid, but the best part of being a passenger is not having to worry about driving through the rain. We are honored and actually enjoy driving our clients through both the storms and the beautiful vistas of investing. So if you are so inclined, go ahead and look out the window and enjoy the pretty parts of your drive, but feel free to close your eyes when the weather turns bad. We’ll get you safely to your destination.

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