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Anatomy of a market crisis

WASIF LATIF 16-Mar-2020

We know that the recent news both in our daily lives and the financial markets has been disconcerting—downright scary—as we learn new terms and concepts like “social distancing” and “flattening the curve.” Certainly, the market hasn’t liked the news. Domestic stocks plunged into bear territory in record time while the yield on the 10-year Treasury plumbed incredible new lows below .75 percent. We recently witnessed a daily swing in the S&P 500 Index in excess of 300 points (almost 3000 for the Dow Jones Industrial Average). No, these are not typos.   


The situation can only be described as a crisis. And though there are far more important things in life than financial markets, the extreme volatility and plummeting value of retirement accounts exacerbate our collective sense of unease. For some, these huge swings and the tripping of circuit breakers conjure up memories of late 2008 and early 2009. Others, including me, remember the bursting of the bubble and the aftermath of September 11. 


But drawing on those experiences should actually give us some measure of comfort and resolve. No, we have not experienced a pandemic in post-globalization times quite like this. Nobody knows how this coronavirus will mutate and evolve. And nobody knows what the impact will be on domestic and worldwide GDP, even as a recession now appears more likely. 


What we do know is that every market crisis like this has a lifespan and follows a certain trajectory. There is a beginning—where it’s risk-off no matter what and we fight to keep control of emotions. There’s also likely to be a period of painful deleveraging, which may include forced selling and some corporate bankruptcies despite any added liquidity measures provided by central banks. That’s the reality.


Yet at some point the market eventually discounts everything to a worst-case scenario. So while we may have a several week (or longer) period where economic activity and the velocity of money slows dramatically, there will be a point where all that gets priced in. And after earnings downgrades and sentiment looks bleakest, the bad news may cease to push the market lower. 


In 2009, for example, the inflection point came after several global banking CEOs made some mildly optimistic comments after the Federal Reserve stepped up with their array of supportive measures. Those comments that “things were stabilizing” were enough to spark a rally that turned into the longest bull market in history. 


Remember, in the panic following the housing market-driven selloff back in 2008 and 2009, the market was looking for bold, coordinated policy action from the authorities. It will be no different this time. In the prior crisis in 2008, it took many days/weeks for Congress to pass TARP (Troubled Asset Relief Program) and provide relief in conjunction with Quantitative Easing measures. Hopefully the coordinated response will come more quickly this time. Already the Federal Reserve has acted twice, and Congress is considering additional legislation. Yet we must be prepared to for the extreme market volatility with very large swings intraday until we get some clear and effective policy response. When that happens, I’m confident that there will be another inflection point that could once again kick-off another long-lasting rebound.


Thus, even though we have not seen COVID-19 before, we have experienced other Black Swan events. We know that this economic turmoil will end. So when the risk-off sentiment eventually flips (and it can flip quickly), we expect to re-enter an era where fundamentals matter again. And while nobody is expecting passive strategies to fade away, active management and active asset allocation – including systematic, rules-based products that believe in certain factors – will again demonstrate their value to investors.