The risk of recession continues to rise and as the risk plays out equity markets fall and treasury markets rally. Stocks generally have fallen almost 20% from their all time highs achieved just a few weeks ago. Conversely 30 year treasuries have risen almost 15% during that same timeframe as record lows in interest rates are embraced. The 30 year treasury is now yielding less than 1% and 10 year treasuries are yielding approximately 1/2 of 1%. If the fear of recession turns into reality treasury yields will undoubtedly move into negative territory across the yield curve and equity prices will possibly fall another 10 to 20%. Gold has not turned out to be much of a hedge for this recent drop in equity prices. While gold has done well at times historically during periods of fear gold has now become a bit more of a commodity used in jewelry and hence tied to economic strength. As recession is embraced investors are less thrilled with gold. Treasuries are a much better hedge for inflation then gold it would appear.
We have moved our qualified asset allocation accounts (DG & AAI) to a 30% cash position over the last week. Our taxable versions of DG and AAI have been moved to a 15% cash position. We have been reluctant to take a stronger cash position in our client’s taxable accounts because the portfolios are full of long-term gains that we wish to avoid taking if possible. As a result we are embracing other strategies to protect our taxable portfolios short of selling big positions in Apple or Amazon resulting in huge long-term gains.
How much further downside might there be in stocks and how much further upside might there be in bonds and treasuries. The answer lies in whether or not a recession lies on the horizon and how deep and hard a recession it might be.
To answer this question we have examined the depth of equity market corrections during the last two recessions that occurred in 2008 (the great recession) and 2000 (the.com bust).
During the great recession in 2008 stocks generally fell approximate 54% from peak to trough. During the recession of 2000 brought on by the dotcom bust and 911 attacks stocks dropped from peak to trough by approximately 47%. Both of these recessions were deep and hard recessions with lots of severe economic problems present just prior to the recession. Inflation was rising, Fed policy was unfriendly, and there was overhangs and excess capacity in housing, Currently the economy is in very good shape with no severe economic problems but contrarily very friendly Fed policy, high employment, high consumer confidence, and strong consumption and retail sales numbers. Our current economic growth phase has been ebbing and flowing for 10 years now and it is likely that the coronavirus will simply slow the economy and cause another Ebb in what was likely to have been a stronger period of growth. It is not reasonable to think that if the economy falls into recession here it will be deep longer hard. Hence it is reasonable to believe that the market will not fall 45% as it is done in the past during deep long hard recessions.
Some pessimists believe that the market will fall further this time because the market is coming from much higher values. I disagree with this logic as valuations in the market today relative to other asset classes are superior to what they were in 2000 and in 2008.
During those periods interest rates were significantly higher and more competitive for stock market money. As a result market valuations today look much better than they did in 1999 or in 2006 just prior to those recessions.
The coronavirus has caused the panic in the economy and amongst consumers and corporate leaders and as a result economic conditions will slow possibly significantly while we contain the virus. So the question becomes how long will it take to contain the virus?. If this is six months or less there will be minimal damage to the economy conversely if this takes one year or more there could be significant damage to the economy.
It is reasonable believe that the market may drop another 10% before it finds at least a temporary bottom while we wait visibility on containment of this virus and the level of shutdown corporate America is forced to embrace.
I expect a V-shaped recovery in the financial markets when visibility of containment is near and if that visibility is seen within the next few months. We will continue to embrace the portfolio appropriately to weather the storm that has begun.
We are optimistic that this will be nothing more than another ebb in our slow-growing economy.