I’m well into my 39th year on Wall Street and I’ll certainly confess that I have never seen volatility like this. Though I’ll spare you the most extreme of the hyperbole, suffice to say that it is not every month that we have both a Bear market (20+% decline) and a Bull market (20+% gain) in quick succession. Of course the Bear roared much louder than the Bull could reverse and charge, so that a fully diversified equity portfolio will have finished the month down nearly 15% in total, and down well over 30% from the mid-February all-time high.

It’s all about the virus

Of course it’s all about the virus. And only about the virus. Long since relegated to the sidelines have been the macro issues of domestic politics and even the oil-price war between Russia and Saudi Arabia, both of which would be front and center of Street consciousness under any environment but this one. It will likely be this way for some time ahead and there seems to be little question that we are facing our first true economic recession since 2008-09.

But let’s put some perspective on all of this from an investment strategy point of view

Yes, this recession will be (or already is) different from every other recession (and this is a vital distinction) in that it has absolutely nothing to do with monetary policy. This one is (quite correctly) mandated by policy-makers at all levels to arrest the spread of the virus and giving the medical profession the time to find (hopefully anyway) a cure. We are under a near-total economic lockdown. The world is under a near-total economic lockdown. This is truly different.

Why this recession is different

By contrast, all prior full or near-recessions in my lifetime have occurred because of either a policy-intended or market-forced tightening of monetary policy, with the economy gradually, or even suddenly, becoming starved for capital. As an example of the former, with massive inflationary pressures overwhelming us all, the double-dip recessions of 1980 and 1982 were created by Federal Reserve Chairman Paul Volcker who physically turned off the capital spigots and therefore forced short-term interest rates well into double-digits. This slammed the breaks on the economy. Eventually inflation was brought under control.

Great Financial Crisis of 2008-09

The most extreme example of the latter was the so-called Great Financial Crisis of a dozen years ago when the markets, after binging on borrowed money to drive residential real estate to stupid-high price levels, finally realized that those prices, and therefore the value of the underlying debt, were unsustainable. Capital availability provided to (and then by) the markets first slowed in the spring and then eventually crashed in the late summer of 2008, and it took months before the policy-makers could reverse it.

Monetary policy still important

Back to today. Even though the Covid-19 recession is different, that doesn’t mean that monetary (and now fiscal) policy won’t be important in first mitigating and then reversing the economic impact. I have counted eight major Federal Reserve programs that have been implemented to keep the financial markets fully functioning. If markets can’t clear properly, you can’t have confidence they are sending the right price-discovery and economic messages important to all of us. We may not like much of their recent action, but they are clearing easily. This is very, very good.

Soon the fiscal ‘balancing’ (let’s not call it ‘stimulus’ yet) from the just-passed and fully bi-partisan CARES Act will become an effective factor. This capital provided to individuals and small business should/will allow basic consumption to be maintained, even if at a lower-than-normal level. There may well be significant – and of course unintended - negative consequences from these actions later on (more below on this) but there’s no question that they are more than appropriate for the right here and the right now.

Combine both the monetary and the fiscal and we have massive amounts of capital created. Since one must presume that at some point the virus will be mitigated either by a cure or a developed general immunity, and since policy makers will likely be very slow (or unwilling frankly) to unwind it, all that capital will try to find a home either in the form of economic activity or within the markets. Of course it’s impossible to know when But it’s out there sometime in the not-forever-away future.

Financial markets

Now let’s talk about the financial markets, especially for stocks.

Well before the virus took hold, I had been a strong advocate for a below-target weighting for stocks in client portfolios, with a strong belief that a ‘baby recession’ and a ‘baby Bear market’ was in our future for some time in 2020. To change my metaphor, the resulting G-rated Bear would be maybe 25-30% in depth and roughly 6 months in duration, to end sometime in late Q3 or early Q4, with a new secular Bull that will define at least the first half of the decade of the 2020’s. That was before Covid-19, which has now already ‘treated’ us to something well into PG-rated (30-40%) territory with the March 23 low down about 37% from that February high. With last week’s and Monday’s rebound, we’re now back to the G-rated status. So where do we go from here?

Four stages for a normal bear market

Much has been written in the financial and now even mainstream media about how bear markets evolve and then end. There are four stages for a ‘normal’ Bear. First comes the ‘shock and awe’ decline as negativity overwhelms the optimism/complacency of a perceived wonderful environment that defined and then topped out the now-ended Bull. The magnitude and alacrity of the decline is generally at its most severe. In my opinion, we can check that box. Stage two sees a rebound of some significance, serving to restore some of that prior optimism and complacency. Though it might feel good, it’s really not – more below. During stage three, a more protracted period of negativity sets in, which returns markets to some degree of a‘re-test’ of the lows set in the first stage. Finally comes stage four when, even though few will believe it at the time, a new Bull market takes hold.

Getting through stage two

In my opinion, the most important thing the markets can do right now is get fully through stage two and establish a true equilibrium price level around which to simmer down. In a Mid-Month Update all of three weeks ago and still under the G-rated premise, I had suggested that might be around 24K on the Dow Industrials and 2750 on the S&P 500. Now under the revised PG, I think the 22K and 2575 respectively might be more realistic, or right where we will close out the month of March.

Once that equilibrium has been established, and assuming nothing new of significance shows up, the markets will ebb and flow 5-10% on either side for a short period of time, waiting for further developments. Though this can be a bit disconcerting, especially if the movement is to the downside, this will absolutely be the normal order of things. Nothing will be wrong and nothing will be broken, markets-wise. During this period, and as long as the markets trade within that range around that equilibrium, no major portfolio decisions should be made.

If/when stage three truly develops and prices decline to within some degree of hailing distance of the March 23 Dow 18+K and S&P 2200 lows*, then it will be absolutely right to re-balance portfolios back to and even perhaps above normal stock-target percentage weights. In fact, on March 20 (yes, a trading day early from the bottom – we’re not that good!) for many clients we did indeed push back into stocks a small amount of client cash/bond holdings, slightly reducing our resolutely long-held stock underweight. If given that same opportunity, we will do so again. And again. Because, as surely as day follows night, the stage four Bull will come upon us.

But here’s a caveat, my follow-up to the two earlier ‘more below’ notes. The virus is absolutely a finite event. It is hideous beyond hideous. But it is finite. If indeed the medical folks can get the upper hand sooner rather than later, it is quite possible that we may skate through all this with only a short-duration, one-time hit to economic activity and to the markets, resulting in no stage three of consequence at all. Everything will go right back to where we started. Sounds great, right! Not in my opinion. Our economy badly needs a re-boot. The financial markets badly need a re-boot. And a real re-boot, with some longer term impact, from which we can then emerge truly in a much stronger position. So though it’s hard to ‘cheer for’ the full completion through stage three for a normal Bear, I believe we will come out far better for it than if we skate by.

I will conclude with my all-time favorite Wall Street saying – The True Purpose of a Bear Market is to Return Wealth to its Rightful Owner. All investor wealth is negatively affected temporarily of course. But it only permanently affects wealth if it is allowed, or forced, to result in precipitous selling at its worst moments. Those who have prepared for the Bear (as we have at KLR Wealth) have the cash on the sidelines to take advantage of lower prices, and then do so, are Rightful Owners. And even those fully-invested who maintain discipline and resolve and refuse to succumb to the emotion of the Bear by selling into its teeth are Rightful Owners. All of us will regain all that wealth (and probably then-some) when the stage four Bull takes hold. That’s the way it works. We, and you, are indeed Rightful Owners.

We at KLR Wealth are always available to address any and all questions and concerns. Please reach out at any time. And please also know we are always paying close attention to all your wealth objectives.

*Famous last words perhaps, but I actually feel pretty strongly that the lows of March 23 will prove to have max-end out the Bear in price terms. In my opinion, anything below Dow 20K and S&P 2350 would be a terrific entry point.

**Bear markets typically last 6-9 months from stem to stern, though since markets trade so much ‘faster’ now than previously, it may all be done well before the mid-August past quick Bears would imply.