The headline referenced above speaks to events that have consumed investor psychology. As millions become infected and the corresponding death tolls increase, the degree of uncertainty and fear begin to influence stock markets around the world. It would be reasonable for us to believe that this headline was written in the last 30 days. In fact, this headline was written in 1918, just as American troops were headed to Europe for the closing offenses of World War I.
America’s Forgotten Pandemic: The Influenza of 1918, by Alfred Crosby, tells the chilling story of the world’s deadliest flu pandemic from a U.S. perspective and offers many details of the epidemic’s international reach. Life came to a standstill in some parts of the United States. Boston officials closed public schools, saloons, and soda shops. Chicago police officers were ordered to arrest anyone sneezing or coughing in public. In Nashville, all public gatherings-including in movie houses, dance halls and pool parlors- were prohibited. Even ministers were ordered not to hold church services.1
The Spanish Flu pandemic would quickly spread throughout the world over the course of 4 months, infecting between 20-40% of the global population. 20 million people died with 500,000 dying in the US alone. The parallels referenced above are striking in their similarity to recent action taken by cities throughout the US. With markets violently reacting to global events, it becomes essential to understand how history may provide some insight into how to best understand what investors can expect and how to best position for a time when infections are contained.
Perhaps one of the biggest challenges facing modern day investors is the fact that few of us were alive when vaccines created for polio, measles, and smallpox helped usher in an era where longevity of the global population is at the highest ever recorded. Despite this shortcoming, we can look to data to provide insight on what investors might expect as researchers work tirelessly to develop a vaccine and treatments to Covid-19.
It’s essential for investors to understand that markets are discounting mechanisms. In the short run, markets are attempting to understand what impact effectively shutting down the economy has on earnings. This is most evident by the violent moves in March as investors began to try and understand what a shutdown of businesses may have on earnings. We also need to understand that there are also economic cycles that must be considered and how the long-term trends contribute to life after pandemics.
Research by economist Robert Schiller provides some insight in what investors can expect in future periods once pandemics are contained. As evidenced by the chart below, the S&P 500 index declined 24.7% in 1918 and increased by 8.9% in 1919. More importantly we can see that markets have consistently increased over time as global Gross Domestic Product increased. In the short run, we tend to forget that there is light at the end of the tunnel. We recognize that pandemics are circumstantial events as opposed to structural or secular markets. The difference being that structural and secular markets require a much longer period to work through inefficiencies or misallocation of resources.
Recent discussions with clients have centered around how long do markets remain depressed? It’s important to remember that markets generally increase on an annual basis almost 80% of the time. Despite volatility, markets do recover. Research by Blackrock informs us that the worst monthly market declines since 1950 have averaged -12.4%; however; one year later markets increased on average 16.7%.
This fact should then provide some insight with how markets rebound. For now, volatility is the new norm. We recently experienced the shortest bear market and the quickest bull market all within a period of weeks. The VIX index, a measure of volatility in markets, eclipsed levels seen during the financial crisis. With so many unknowns, what is an investor to do? In short, have a plan and stick to it! Research into 7 Bear Markets since 1982 illustrates one year returns from bear market bottoms for US stocks have averaged 41.1%. This fact demonstrates the difficulty in timing market bottoms. The chart below highlights returns for various asset classes and the one-year return from bear market bottoms.
Although we are viewing market data in isolation, we cannot ignore the policy levers that have been pulled in response to this exogenous shock. From a monetary policy perspective, the US Federal Reserve has executed a familiar play book. The 2008 Financial Crisis influenced the Fed to develop tools and mechanisms to stabilize markets that were executed over the course of 3 years. These tools helped contribute to a greater than 300% return from market lows. Amazingly, the Fed responded to this crisis with conviction and speed rarely seen through the deliberative body, executing, and building upon its crisis playbook over the course of weeks instead of years!
Recently, Congress passed the CARES Act attempting to blunt the effect from such a rapid shutdown of the economy. It provides direct payment to American workers, in addition to programs such as the $349 Billion Payroll Protection Program and Economic Injury Disaster Loan Program. It’s difficult to see the forest through the trees when fear influences our judgement. However, as the rate of infections decline and the curve flattens, we cannot ignore what lies on the other side, and that is a highly accommodative landscape for consumers and businesses alike. Given the highly coordinated global response, we believe the economy will pivot from extreme short-term pain to eventual healing over the next 6 to 12 months.Many forget the opposite side of fear is opportunity. Although the slope of the recovery trajectory is unknown and more likely to resemble a “U” as opposed to a “V”, we do know that markets recover and that opportunities are created in crisis. We continue to rebalance portfolios adding to areas that have been disproportionately affected by crisis and restoring the risk budgets that have drifted during crisis.
1 Perspectives in Health Magazine,The Magazine of the Pan American Health Organization
Volume 8, Number 3, 2003 Magazine
