by Jordan Hucht, CFP®, ChFC®, AIF®
We’re in the midst of an unprecedented public health crisis that will have a sure, yet undefinable, economic impact. We’ve been swimming against the current in a river of seemingly endless bad news, on both the public health and financial markets fronts.
It’s a fluid situation with countless variables and unknowns. And there are probably several questions front and center on your mind.
Why is the stock market selling off?
Stocks are primarily priced based on a multiple of projected future earnings. With large swaths of the economy grinding to a near halt, we know that corporate earnings will suffer. That alone drives down the value of a company’s stock. But the bigger problem is that we don’t know by how much, so the primary driver of stock valuations – earnings – is a big unknown. With that big question mark around earnings, it’s impossible to accurately value stocks, so investors are willing to pay far less.
The uncertainty around the level and duration to which earnings will be negatively affected also breeds extreme volatility. You’d have to look pretty far back to see a period of time with the same level of extreme and sustained volatility as we’re seeing right now. Terrible days are often followed by great days (think last Thursday, then Friday), but there’s a lot more bad than good in the market right now.
When will it stop?
The honest, though unsettling, answer is that it’s impossible to know for sure. So instead, let’s consider what it will take for the market to settle. I’d look for three main things to be happen before we can expect the market to settle:
- Address the public health crisis and “flatten the curve” of new cases. As you’re surely aware, more extreme measures are being taken every day, which is a good thing. The sooner we can feel confident that we’re nearing a peak in the number of cases, the sooner we can begin to gauge the economic impact. There is obviously still work to be done on this front,
but progress is being made.
- Keep financial markets functioning correctly. The Federal Reserve’s most recent actions are aimed to provide liquidity to the markets and maintain orderly buying and selling of securities. Yes, we’d prefer to be in a situation in which the Fed does not to need to act, but this is a critical role the Fed can play. There may be more work to be done on this front, but
the Fed seems very tuned in to the situation.
- Provide fiscal support to limit the economic damage. This applies to both people and companies. To prevent an economic tailspin and instead position ourselves for a swift recovery, we need a comprehensive approach to helping those who are out of work pay their bills and backstop companies from laying people off and potentially going out of business. A lot of work needs to be done on this front. But it has started, with several pieces of legislation being introduced in Congress.
How bad will it get?
At this point, with the major indices down roughly 30% from their most recent highs, the market has fully priced in a recession. Whether we see a recession or not is yet to be determined. We’ll almost certainly have at least one quarter of contraction, and two consecutive quarters (the technical definition of a recession) is certainly a possibility. Again, at this point, the market has fully priced in a recession, based on historical stock market declines during recessions. Remember that we don’t yet have any real data on the severity of the economic impact, as companies have not yet released Q1 earnings, and we won’t have a read on Q1 GDP until April.
Things could certainly get worse before they get better. The news, at least in terms of newly confirmed cases, will certainly get worse before it gets better. But other news, like progress being made on a fiscal support package, could get better. There are also some hidden positives that could prove to be tailwinds once the outbreak is contained. The huge wave of recent mortgage refinances will put more dollars in consumers’ pockets. Low interest rates and low gas prices are also bullish for consumers. And pent-up demand for goods and services after weeks (or possibly months) of quasi-quarantine could emerge as the outbreak subsides.
What should I do?
Assuming good financial planning has been done and your asset allocation matches your time horizon and cash flow needs, the likely answer is “nothing.” However, it’s always a good time to revisit your financial plan, cash flow needs, and asset allocation. In times like these, revisiting the financial plan and remembering why we’ve allocated assets appropriately gives us solace and prevents emotionally driven decisions.
With that being said, there are some opportunistic things that can be done without venturing off course. For example, we’ll consider tax-loss harvesting in taxable accounts, which will allow us to derive a positive result in a negative market. Rebalancing drifted portfolio positions back to their target allocations will provide a natural buy low/sell high methodology. And for younger investors with long time horizons who have been waiting to deploy cash into equities, beginning to slowly put
money to work in this market could prove opportunistic over the long term.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.