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When Will This Be Over?

I just returned from a long-planned trip to Colorado with two of my kids.  In addition to skiing (a fairly new sport for me) I had the opportunity to visit with a client who lives there and is a (early) retired Wall Streeter.  The trip out there took us through Chicago’s O’Hare airport.  I was interested to see the level of activity and what precautions people were taking.  In short, it was crowded like I remember it being from the past, and very few people were wearing masks and/or gloves.

In Steamboat Springs, although I have never been there before, it seemed like business as usual.  The slopes were crowded most days, and the restaurants were always full of people.  Up on the mountain they have several lodges with “food courts” and seating for hundreds in tight quarters and they were full each time we went.  The demographic there was very diverse by age and gender and no one was talking about coronavirus.

Before and during the trip our team communicated with each other regarding the market volatility we have seen in the last week.  Fortunately, we made some changes to our portfolios a while back that have helped dampen some of the effect of the wild swings we have seen so far.  Our more conservative strategies have generally lost much less than the stock market.  Why?  Because those strategies are invested more in things that investors have been flocking to for safety like bonds.  Regarding all strategies, one of the risk controls we have had in place for years is a fund that can be fully invested in the eleven sectors of the S&P 500 or fully in cash or somewhere in between.  While that strategy was built to minimize the damage of major declines over longer time periods (like the 50% decline in the S&P 500 from October of 2007 to March of 2009) it has been raising cash and has cushioned a fair amount of the most recent decline.

Traveling back to Wilmington Wednesday the scene in Chicago was the same.  But then after landing Wednesday night I learned the NBA suspended their season and the NCAA tournament was cancelled (a birthday I won’t soon forget!).  There was also a lot of negative press of President Trump’s prepared remarks about ways his administration is dealing with the crisis, from a health and economic perspective.  Because the House and Senate are divided politically, both parties are jockeying to be the “crowd favorite” with voters in an important election year.  The markets didn’t like any of that and promptly sold off yesterday for its worst day since Black Monday in 1987. This morning it looked like a strong rally was forming but that waned quite a bit by late morning only to rally back this afternoon.  This is how it is likely to be until a bottom is reached.

Despite the number of infections and deaths in the United States being relatively small, the virus is spreading and doesn’t seem close to peaking yet.  How this will affect the markets is unknown but despite the panic selling we have seen in such a short period of time, we aren’t naïve enough to think it’s over.  With that said let me give you a little perspective from a call we had with Goldman Sachs on this type of market movement versus others that will hopefully provide some comfort in the midst of the storm.

Historically there have been three categories of bear markets, structural (or secular), cyclical, and event driven.  The first, a structural or secular bear market are often brought about by bubbles bursting.  The 2008 financial crisis is an example.  During secular bear markets stocks decline an average of 50%.  These are less common but the most damaging.  It can take as long as ten years for the markets to recover to the previous high in this type of bear market.

A cyclical bear market is often brought about by less subtle things like the end of an economic or business cycle (i.e. recession) and changes in interest rates.  A cyclical bear market averages a decline of around 30% and takes around four years to recover to the previous high.

The third type, and the one we are seeing now, is event driven.  Event-driven bear markets, like the Long-Term Capital Management fiasco in 1998 and previous pandemics like SARS and MERS cause the market to decline around 30% on average.  As of yesterday, the S&P 500 was down almost 27% from its peak only three weeks prior!  The greatest difference beyond the extent of an event driven downturn is the time to recover.  On average, recoveries from event driven bear markets are about one year or less.   I would like to be able to predict that we will see a sharp recovery from this panic we are in the midst of, and while I hope that is the case, I think it’s smart to consider what else could happen.  Coronavirus could cause a big enough economic slowdown to tip the economy into a recession resulting in a cyclical bear market with greater downside.  However, we believe that if the infection rate declines within a month or two then we could avoid a recession (even though we are currently in the longest expansion period ever) and see strong economic growth from pent up demand and spending going back to earlier levels.

As I said in my commentary last week click here, panic selling results only in losses.  Because what we are seeing right now is event-driven, we have to stay focused on the long-term while being realistic as to how this plays out.  We never like to see losses but getting out in front of markets like this is almost impossible. It’s what we do during times of prosperity that impacts how you do in times of crisis.  We design our strategies during periods of calm specifically so that we can stick to them during periods of market volatility.

Finally, I want to ask you to do two things.  First, call us if we haven’t already talked and you want to know how you are doing.  Second, please forward this to someone who you think could benefit from our perspective and proactive approach.  Many of our clients have come to us during challenging times to help them sort out the impact their investments are having on their financial goals and lives.  Taking a big picture, holistic approach to being a personal CFO connects the here and now with the yet and then for our clients’ lives.  It’s what makes IronGate the firm we are today almost 16 years (and several bear markets) after our founding.

Stephen C. Coggins

Chief Investment Officer

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