What is the Market Signaling?
by Charles Cheng, CFA
From the market peak on Feb 19th to March 23rd, the benchmark US S&P 500 Index fell over 33%. It then subsequently rebounded over 24% over the subsequent month, retracing roughly half of the losses, due to the effect of compounding. The initial fall was due to the outbreak of the COVID-19 pandemic and subsequent economic fallout, where US unemployment filings have hit unprecedented levels. The bounce back was almost as dramatic, but the question remains whether this signals a better outcome than previously expected, or if it means anything at all.
S&P 500 Index (source: Bloomberg)
Previously, I discussed that the eventual path to recovery from a health and economic point of view depended on government pandemic response, economic stimulus response, and future scientific breakthroughs, things that are difficult to predict in advance, and therefore investors should be prepared to react to plausible scenarios of a quick recovery and prolonged pain. So far, the market has bounced back without any meaningful developments in any of these areas, which begs the question, what is being discounted into stock prices? If we knew the answers then we could at least anticipate whether a future outcome would leave the market disappointed or pleasantly surprised.
Any student of investing has learned about the market being a synthesizer of all available public information, which makes beating it such a difficult job for even professionals. But being unpredictable does not mean that prices are necessarily real time accurate reflections of reality. In a month where oil futures traded at negative values, and fixed income ETFs swung from large discounts to NAV to premiums, we see that technical considerations sometimes dominate especially during dramatic dislocations.
Vanguard Intermediate Corporate Bond ETF
If we were to rationalize the rally, we could say that investors were reassured by the Fed’s willingness to do whatever it takes to prevent the economy from going into a prolonged depression, taking actions such as buying non-investment grade bonds from the market to stabilize prices. Whether that optimism should extend beyond the market into real world outcomes, where the virus is still spreading and killing without a coherent national plan to combat it is another matter. Perhaps, it’s better off not to rationalize and accept that in the short term, the market does whatever it wants unpredictably, but will eventually reflect fundamentals in the long term.
As always, we can look to the past, not necessarily to see patterns that could happen again, but to see what is possible in the market given our knowledge of how the future played out.
Dow Jones Industrial Average, 1931
During the recent bounce back, many financial media publications reported that the bounce back in the Dow Jones Industrial Average included the biggest three-day surge since 1931 (Over 20%). Consider that in 1931, saw rallies of 27+% and 35+% and declines of 37% and 44.3%, and finished the year down over 52%. Therefore, it is not unprecedented to have massive rallies in the middle of a large decline, and one should not read too much into the current one. However, it would also be a stretch to think that the market will closely follow this particular historical pattern considering the difference in circumstances. For one, the monetary response from the government in present day is much more potent. On the other hand, they were not dealing with multiple waves of a deadly disease in 1931. As before, one should keep both their mind open and portfolio strategy flexible (for example, defensive but opportunistic) to deal with what’s to come.
在最近的反彈中，許多金融媒體刊物報導道瓊斯工業平均指數的反彈包括自1931年以來最大的三日漲幅（超過20％）。1931年的漲幅分別為27 +％和35 +％，跌幅為37 ％和44.3％，而全年下跌超過52％。因此，在劇烈下跌中穿插大幅上漲並不是史無前例的，人們不應該過多解讀當前的情況。但是，考慮到環境的差異，很難想像市場將嚴格遵循這種特定的歷史模式發展下去。首先，當今政府的貨幣反應更為有效。另一方面，他們在1931年政府無需同時應對多波致命疾病。像以前一樣，人們應該保持開放的態度和靈活的投資組合策略（例如，保持防禦性的同時保有機會主義）來應對即將發生的事情。
Mr. Cheng is a managing partner at a Hong Kong based independent private investment office. This article reflects his personal views and not his firm’s and should not be viewed as an investment recommendation.