As a result of the severe downside volatility in stocks over the past three weeks, I’m back to give you a rare mid-month market update.. Yesterday’s 2000+ point decline in the Dow Jones Industrial Average, coming on the heels of massive swings the two weeks before, put it well into the top 20 of percentage declines in the past 100 years. Such is the nature of the current market structure – more below.

Baby recession and baby bear market in 2020?

First and foremost, as noted ten days ago and in every (yes, every) Monthly Update since I came on board as the KLR Wealth Chief Investment Officer a year ago, we have been prepared for this with an underweight to stocks relative to long term client targets. This was based on my sense that a Baby Recession, and with it a Baby Bear Market, might well occur in 2020. This didn’t feel very comfortable in mid-February when a fully diversified equity portfolio was up more than 15%. A quick 22% decline later – which meets the percentage definition of a bear market – it doesn’t feel quite so bad.

So what is that structure?

I read a very interesting insight over the weekend that the owners of the so-called ‘smart money’ and ‘dumb money’ have completely flipped. The long-time presumption on Wall Street was that the big money institutional investors, with their battery of accomplished research analysts and generally long-term orientation were ‘smart’ and that the ‘Mom and Pop’ investors, over time quite prone to ‘buying high and selling low’ were the opposite. No longer. Since the markets emerged from the Great Financial Crisis (the exact bottom, ironically, happened to be exactly 11 years ago yesterday) so much emphasis has been put on the big money managers for short-term performance that, in my opinion, they have become the ‘dumb money’. Those who don’t fret about last quarter’s (or last week’s or yesterday between 2:30-4PM) relative performance and who therefore can avoid succumbing to the price momentum of the moment, however, have become far ‘smarter’.

Three quick – and perhaps obvious – causes of this amazing, all-of-a-sudden volatility.

Two were the buses* noted in my March Update – the still-spreading coronavirus and the change in the political equation, especially now that former VP Biden seems to be the likely Democratic nominee. Over the weekend came a third, which my friends at Gave-Kal Research equated to throwing a hand grenade into a bloodbath-- OPEC’s Russian-led refusal to agree on oil production cuts to support the oil price in the face of virus-generated loss of demand followed by Saudi Arabia’s decision to really open the production spigots. Crude oil prices crashed to near early-’16 lows, taking stocks of all energy companies and banks big and small active in energy financing. Conspiracy theories abound of course in the midst of volatility…but there is no question that the business models of virtually the entire highly-leveraged American oil shale industry, are being eviscerated right now.

Internal strains in the economy

As noted in my February Update, if there was ever a time an insidious external event were to affect our economy, it would be now, with our largest-ever breadth and depth. But, as the markets are fretting about now, perhaps it will have met its match in the coronavirus. Last week’s jobs report from February was very strong but even that, according to Ned Davis Research, was showing internal strains, such that its proprietary Employment Trend Index was at its weakest level in ten years. We’ll see over the coming few weeks whether this weakness starts showing up on the every-Thursday release of first-time unemployment claims. They’ve been solidly holding a 200K-220K level for a very long time. A sudden increase to 250K and above will not be good.

What will be the impact of the “baby bear market”?

After a similar price decline in Q4’18, from my prior perch I noted that a Baby Bear Market would be one of roughly 25-maybe-30%, in depth. If so, we’ve already endured the vast bulk of it, and since such price reversals now happen so, so fast due to the now-dumb-money, high-momentum effect, we are now more likely than not past the point of maximum steepness. This doesn’t mean volatility is going away, but I would like to think it will simmer down sooner versus later.

Therefore, assuming we don’t do an equally sudden ‘v-shaped’ reversal as we did after the Q4’18 decline (which I would regard counterintuitively as terrible for the long run health of stocks – a later Update topic perhaps), we are more likely ‘back-and-forthing’ around a new equilibrium price level, which I would pinpoint at about 24K on the Dow Industrials and 2,750 on the S&P 500. When the final story is written, I would suggest there’s a few more percent on the downside and, perhaps more importantly, quite a bit of time and space ahead between today and that final low point. For the sake of an aggregate target, I would guesstimate that to be early autumn at about Dow 22,500 and S&P 2,550, roughly 6-7% below yesterday’s blow-out selloff close.

That said, since my late ’20 and ’21 sense is a return to a secular bull market promising much higher returns ahead, we at KLR Wealth are now far more likely to consider adding to our client stock portfolios over the next couple of calendar quarters. That’s not necessarily right away but neither is it far away.

Stocks in the context of a client-driven long-term wealth objective will always be important, so I will close with the words of the Isley brothers in their immortal 1966 This Old Heart of Mine hit.** Stocks today ‘got me never knowin’ if I’m comin or goin’, cause I love you, yes, I do…”.

We encourage you to stay true to your long-term goals and asset allocation.

We at KLR Wealth are always paying close attention and are always here for you. We welcome your comments, concerns and questions.

David Wray

Chief Investment Officer

*To repeat a long-time favorite metaphor – you never get hit by the bus you can see, only by those you can’t, or chose to overlook.

**a staple of the Wray Spotify playlist – I’ve got 125 songs and know all the words by heart.