03/10/2020

Volatility continues to torment investors and the U.S. equity markets have officially moved into bear market territory. This simply means that stock prices have dropped by 20% or more. What has been breathtaking about this sell-off is how fast the markets are moving. Just three weeks ago stocks were trading at record high levels and we are now seeing repeated single-day market movement of 5% to 10%.  

The current drop into bear market territory will mark the fastest such move on record, dating back to 1915. The average number of days from peak to bear market territory is 255, the median is 156. This time around the Dow Jones Industrial average managed to achieve this feat in less than 20 trading sessions. To be clear, the sudden collapse in equity prices has been extreme by any historical standard.

This is a difficult time for investors and people are understandably nervous. As always, our best tools for navigating any sharp drop in equity markets will be data and historical perspective. Both would currently suggest that the sell-off is overdone and that panic has taken over. This said, the extent of the coronavirus outbreak remains unclear and the economic effects have yet to fully play out. It is this uncertainty that is fueling the fear.

We estimate that the market is currently pricing in a truly historic collapse in corporate earnings, perhaps as much as 50% to 80 % year over year. For context, we look back at 2008 and the Great Recession when earnings fell by about 46%. Since World War II, corporate earnings have declined by an average of only 18% from peak to trough in a recession. Earnings moved lower by 9% during mild recessions and plummeted by 25% during deep ones (JP Morgan). A decline of 50% to 80% would be most extraordinary. Possible, but unlikely.  

Like crises in the past, this one will eventually wind down. It may be difficult to see the other side of all this right now and we still must recognize the economic disruption resulting from the outbreak is likely to be significant. However, we believe the impact will be temporary and the recovery could be every bit as stunning as the downdraft has been.

We agree with Bob Doll, chief equity strategist at Nuveen, when he observes that a market bottom is more of a process than an event. Typically, a large sell-off on big volume is followed by a rally and a retest of the lows, as was the case in 1987, 1998 and 2011. Equities have become significantly cheaper over the past several weeks and a meaningful buying opportunity may soon emerge.

After moving incrementally to a more defensive posture over the past year, we have determined that the time has come to begin developing strategy relative to a rebound. The bottoming process will be messy, and no one can be certain when exactly markets will turn. This said, we believe we are well positioned to begin work on an eventual shift back to a growth (i.e. recovery) orientation.

These brief and more frequent communications will continue as we move forward. We wish to be as transparent as possible as together we find our way through this crisis. Please do not hesitate to call with any questions or concerns you may have.

Regards,

John

John E. Chapman

Chief Executive Officer

Chief Investment Strategist

Clearwater Capital Partners