At 401(k) Engineers, it is important to us that you are well informed about what’s happening in the markets. Here are a few of the key topics of conversation that we feel deserve the most attention this month. If you have any questions or would like to continue the conversation, let us know, and we appreciate the opportunity.
Perfect storm creates historical market volatility
What’s going on?
Over the past month, the potential economic impacts of the coronavirus have continued to grow. In response, governments and organizations around the world have implemented additional measures to mitigate further spread. To make matters more complicated, the negative economic impacts of the coronavirus we’re enhanced when Saudi Arabia and Russia attempted to destabilize the oil market by igniting a price battle that sent the energy sector into an immediate tailspin. President Trump made an address to the nation in which he reassured Americans of a fiscal stimulus to help small businesses adversely affected by the outbreak. Furthermore, the Federal Reserve activated extraordinary monetary support of 1.5 trillion dollars to ensure markets continue to operate efficiently.
Why is it important?
When expectations for growth are set, the value of future cash flows is assigned a price. That price represents what investors are willing to pay to participate in the benefit of cash flows generated from future growth. When changes are made to expectations, the price investors are willing to pay changes. If a company wants to expand its value and raise the price of what an investor is willing to pay to own a share, they create strategies which they believe will outperform investors’ expectations of future cash flows. On the other side of this scenario, when unforeseen shifts happen in the global economy, such as China effectively shutting down a significant supply of materials to the world, the expectations of future cash flows are reduced, and the price investors are willing to pay for a share of ownership goes down. Of course, many other variables play into the price of an investment. However, this is a crucial baseline understanding of why the markets are selling at their current velocity. The US economy has enjoyed the longest bull market in its history. After 11 years of going up, the worldwide halt to nearly every country’s workforce due to the potential impacts of the coronavirus has ignited an aggressive repricing of investments. By aggressive, we mean historic, as the S&P 500 and Dow Jones Industrial Average dropped 20% off their highs in the shortest amount of time on record, achieving bear market status in the process.
What do we think about its potential impact?
The most puzzling piece of the current market and economic environment is that the risk limits have yet to be identified. When risk limits cannot be accurately determined using historical or current data, speculation begins to increase. Until leadership studying the coronavirus can identify the risks and economic impacts associated with those risks, speculation will continue as to future cash flows and whether they are worth their historical units of measured risk. Simply put, unknowns cause anxiety, and anxiety can become fear, which then moves price in irrational ways. The only way to regain stability in price is to turn fear and anxiety of the unknown into confidence and certainty. In rising markets, various asset classes tend to perform at different speeds as pockets of economic cycles reward different companies at different times. In falling markets, there is nowhere to hide. As speculation, anxiety, and fear permeate throughout the marketplace, the “sell everything” megaphone causes all assets to fall, some well beyond their justified valuation levels.
The month ahead:
In late 2018, the markets sold off at a rapid rate, nearly dropping 20% from their highest peak. At that time, there was not much certainty as it pertained to the trade negotiations between the US and China. Once clarity was reached, investors were able to exhale and reassign price using known variables. In the current selloff, we do not yet have clarity of the global economic impacts of the coronavirus, oil price wars, fiscal stimulus, and monetary stimulus. Until the unknowns become knowns, it is not unreasonable to assume that severe market volatility could continue until next month’s writing of this update. On a positive note, the US economy came into the current bear-market in a strong position with a healthy consumer, which is much different than the financial crisis of 2008. If the economy can rally back behind the strong labor force and US consumer, we could see a recovery sooner than later.
The bottom line:
Developing a rules-based strategy for your investments, which eliminates emotion from allocation decisions is a huge advantage during big market swings. It empowers an investor to gain confidence in a process that has been battle-tested and designed for moments such as these. Creating a financial plan that meets your long-term goals and then assigning strategies to achieve those goals over the long run is the best way to compound your wealth significantly. Our investment strategies employ multiple mathematical approaches that add durability and strength during bull and bear markets. We’ve got a plan, and we’re following it.