February 28, 2020

SHARE

The headlines are impossible to ignore. February 27^th was the worst Dow Jones Industrial Average point drop ever. The fastest 10% market correction ever. $3.4 trillion of value has been erased from the S&P 500 since February 19^th. And, yes, these headlines are true. But headlines are not investment philosophies, and they don’t tell us how to invest. We would like to provide Cutler’s thoughts on how our clients should approach the current market. You are always welcome call us to discuss your account or market concerns.

There are two variables driving stocks lower: fear and fundamentals.

Fear is the “elephant in the room.” Investors are rightly scared of the possibility of a global pandemic. This outcome could have severe economic and human consequences. None of our comments are intended to trivialize this possibility. However, fear is a component of the market sell-off that artificially depresses prices. Once the fear subsides, prices can return to their equilibrium.

Fundamentals can have a more lasting effect. Will a complete shutdown of China’s economy have long-term impairments of the global supply chain? Will global travel and trade slow to a halt? What will be the economic impacts of these outcomes?

The balance of these two variables should reflect the true value for equities. With the VIX index (often called the Fear Index) spiking by over 150% over the last week, fear has clearly played a large role in the recent sell-off. But, let’s consider some other fundamental numbers:
 

• The rolling 1-year return of the S&P 500 through 2/27 was +8.8%, even accounting for the sharp drop that has happened this week.¹  Gains going back multi-year periods are also still quite strong.
• The 10-year Treasury yield has reached at an all-time low under 1.20%.  Low yields support economic activity, encourage equity ownership, and mean bonds are working as a diversifier from stock losses.
• The trailing P/E of the S&P 500 has dropped from 18.5 as of 12/31/19 to about 16.5 as of 2/27/2020. Valuations were stretched, as we noted in our latest Commentary, but they have come down.
• The best performing global index year to date is the Shanghai composite, right near the nexus of the virus.² This exemplifies the value of diversification and the need to maintain investment discipline.
• This is the 26^th market correction of greater than 5% since the financial crisis.³  Market drops happen on an ongoing basis and are a normal component of stock investing.