The S&P 500 fell 8.8% last week to 2711.02. It was one of the worst weeks on record for the market (even with the 9.3% gain on Friday). The S&P 500 bottomed on Thursday at 2478.86, held that low on Friday, and then rallied into the close. The late hour rally is potentially significant as it may signal a relief rally coming soon (the futures are down 9.55% Monday morning which means no continuation rally today). The late buying is largely attributed to the Federal Government finally outlining a major relief plan, rather than continuing to attempt to minimize the risks surrounding Covid-19. Perhaps that’s what led to the last hour rally that accounted for the bulk of the day’s gains. It’s also possible the frantic buying into the close had more to do with how oversold the market was by Friday morning. In other words, it may just be that investors were ready to buy after a historic decline. After all, the VIX peaked at 77.57 last week, the highest volatility reading since the last bear market. It’s still a very high 57.83 – normal is between 10 and 20. Volatility readings above 50 tend to be associated with reversals and relief rallies. The likelihood of follow through on Monday is high, assuming no major negative news over the weekend (again not looking like a relief rally today, but one is still possible since the S&P 500 held 2400 in early trading). Continued buying on Monday (later today) probably results in a relief rally numbered in days and perhaps weeks.

Relief rallies don’t last. There are many trapped sellers at higher levels who will take the opportunity to sell into any bounce. Eventually, we will probably see the market roll over and head back down. The length of the bounce and strength of the bounce will help give us an idea of how much pain is still ahead of us. A reasonable downside target is 2346.5; the December 2018 low. The S&P 500 peaked at 3393.52 on February 19th. A drop to 2346 represents a 31% decline, about the average for a bear market associated with a recession. It’s likely we’ll see more selling in the coming weeks but perhaps not before a bounce that takes us to 2830-2940 first. Taking an educated guess about what the market is likely going to do over the next few weeks should NOT be used to make investment decisions. Rather, it’s intended to help us try and understand what we might expect in the near-term and what the market is signaling about the economy.

A stock market recovery from current levels over the next few months tells us the underlying economy is probably holding up and no recession is on the horizon (not my view). A decline in the coming weeks to around 2300, but not much more, is signaling that the stock market is expecting a mild recession (the most likely case in my opinion). An ongoing decline to 2,000 in the coming weeks or months is an indication that the wisdom of the crowd expects a more severe economic contraction (certainly possible but less likely than a mild recession). We will just have to wait and see how this bear market plays out in the coming weeks and months. Fair warning: Anyone who tells you they know what’s going to happen is full of themselves.

It’s Nice To Get Paid While You Wait

We haven’t seen volatility like last week since the 2008 bear market. The good news is that there is a growing list of companies that will almost certainly make great investments over the next two to three years. The bad news is that buying them now might result in short-term losses, perhaps significant. One of the problems with value investing is that people aren’t hardwired for it. We’ve written about this before (see last week’s newsletter). Even when they say they understand that buying good companies on sale means buying stocks that are falling they still aren’t prepared for the short-term losses that accompany the process. Just as no one seems to have the ability to predict market bottoms, no one can predict individual stock bottoms either. Short-term losses almost always accompany initial buys. Furthermore, buying out of favor companies means waiting sometimes years before reaping the reward for buying companies for less than they’re worth – one of the reasons we favor buying companies paying a healthy dividend. It’s nice to get paid while you wait.

We will likely start adding to our current positions and initiating new positions over the next few weeks. Many of the stocks we’re following are at or near 10-year lows and trading for sharp discounts to normal valuation levels. Meanwhile, we’ll continue to monitor the economy and markets to help us better understand how the ongoing Covid-19 emergency may impact our existing investments as well as any new positions we’re considering.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist