In another wildly volatile market session, equities, as measured by the S&P 50,0 rallied roughly 9% on Friday to erase much of Thursday’s historic sell off. Nevertheless, overall markets remain just at bear market territory, down 20% from their February highs. The one question that is consistently on people’s minds is when are the markets going to bottom? Nobody has that crystal ball, in large part because the disruptions to the economy from social distancing measures are so unprecedented. However, we can share with you several items besides market technical and fundamental indicators that we are looking for that will contribute to that process.
- Steps being taken for severe social distancing to slow the spread of the virus. The first step in solving a problem is to admit you have one. The widespread cancellations of large gatherings, sporting events, travel limitations, school and university closures, while incredibly disruptive to the economy and everyday life, is clearly the first step in the bottoming process.
- A comprehensive and coordinated, non-partisan, “all of government” fiscal and monetary response. After a slow start, the Federal Reserve’s liquidity infusion into the short-term banking system combined with Friday’s more comprehensive fiscal response addressing everything from student loan interest, unemployment benefits and small business assistance to strategic oil reserve purchases, there is now a clearer picture that all of the Government’s weight is behind us from an economic and financial markets stability standpoint.
- Measurable progress on the health side of the equation. In the near-term, this includes test kit availability and signs that the social distancing measures are helping to stem case growth. Longer-term, however, to truly put this in the past, it means effective therapeutics and ultimately a vaccine.
The first two of these now appear to be in place. The third will take time and could remain elusive in the very short term. As a result, this bottoming process could remain messy, filled with fits and starts, as the market reacts to new virus-related news. But with the events of this past week, there now seems to be a shared sacrifice mentality in place that gives us great confidence that we will rise as a society to the current occasion. We always do, through even the darkest events of our history.
In addition, and perhaps most importantly as it relates to your portfolio, we steadfastly maintain that the long-term value of a high quality and diverse basket of stocks, does not change even remotely as much as share prices can swing in the short run.
To illustrate this, a typical discounted cash flow used to value a business, or a collection of businesses like what you would find in a diversified stock portfolio, is typically comprised of ten years or forty quarters of projected cash flows plus a terminal value that stretches the time horizon even further. These projections are all then discounted back to a present value at a rate that, amongst other things, reflects prevailing interest rates, which have actually fallen in the current environment. In the overall valuation equation, the next four quarters’ cash flows might represent a grand total of 5% of the business’ intrinsic value. This assumes the next four quarters of cash flow are completely wiped out, as in zero. It also assumes the business has the balance sheet to endure the disruption, which would be mitigated within the context of a diversified portfolio of quality businesses. If they are simply down 20% over that period, the cash flow disruption would represent roughly 1% of the business’ long-term, intrinsic value.
Yet at the height of the recent selloff, stocks were down close to 30%. Therein lies both the disconnect and opportunity that short-term market swings can create and why WE DO NOT PANIC provided we continue to follow the three tenants of investment stewardship we reference time and time again: diversification, quality and time and then combine it with an overall asset allocation suitable for your time horizon and unique circumstances.
We will continue to proactively update you on various macro and micro topics as the current market situation unfolds. If there is any specific topic you would like to discuss with us personally or aspect of your portfolio to review, please do not hesitate to reach out to your Ancora team and we’ll get right on the phone.