WHEN “WHEN” IS TOO LATE

The Market Will Lead the Way

Given that equities are roughly 30% off their highs, I have spent the last week asking a wide range of investors when they plan on adding to equities. The response has largely been centered around the concept of “When”: 

• “When coronavirus cases in the U.S. peak”
• “When the number of deaths from the virus decelerate”
• “When we show signs the the virus is being treated effectively” 
• “When hospitals are no longer under stress and are supplied with enough PPE”

The trouble is, the market simply does not work this way. It does not wait for news, but rather is constantly trying to get ahead of it. This is why “waiting for when” will always be too late. 

Listen to the Market

Given that the market is a reflection of millions (if not billions) of people’s views across the world and does not have biases or blindspots, it sniffs out trends and developments well before any individual, expert, or firm. This is why Barton Biggs, Morgan Stanley’s legendary market strategist, often made the case that, 

“We all need to listen to the market, observe what it does at crucial turning points, and ignore what the experts and commentators are saying.” 

If so, at a time when we are facing a deluge of predictions pertaining to when the Coronavirus may slow down or recede, maybe we should pay more attention to what the market is telling us.

Eighty Years Ago

The U.S. government knew a threat was looming, yet did little to confront it. Many Americans ignored this threat since it was taking place halfway across the world, while others simply did not believe it would reach our shores. Then, when it did, the country was woefully unprepared to combat it. Sound familiar? The Coronavirus and World War II share a lot in common. 

BATTLES OF THE CORAL SEA AND THE EASTERN FRONT

From 1939 to 1941, a world war was raging in Europe and Asia. However, the U.S., protected by massive oceans on either coast, chose to remain neutral. The U.S. government and Americans simply didn’t believe it was our problem. It wasn’t our risk. It wasn’t our fight. Yet, the markets were telling a very different story. Over those two years, the Dow Jones Industrial average fell by more than 20% in 1939 and 1940, accelerating in 1941. Yet, Americans still tried to ignore it. That is, until December 7, 1941. 

On that “Day That Will Live in Infamy”, Japanese bombers appeared over Pearl Harbor and nearly destroyed the entire U.S. battleship fleet in the Pacific. It would go down as the largest intelligence failure in U.S. history. In the weeks that followed, Americans lived under the threat that it would happen again. There were rumors of another pending attack and fear gripped the nation. Pessimism in the U.S. skyrocketed. 

While the nation was just coming to grips with the severity of the situation in late 1941, the stock market had understood it quite well having fallen more than 30% by the time of Pearl Harbor. Then, over the next 4-6 months, the news would only get worse. The U.S. tried to ramp up the production of war-related goods, recruit and train troops, and develop intelligence operations, but this would take time. 

Meanwhile, it felt like the U.S. military was falling further and further behind. The Japanese were winning decisive naval battles in the Pacific and the Germans were occupying most of Europe. Things were looking ominous for the U.S. and allied forces. Pessimism was reaching a crescendo. Then, while few people realized it at the time, the tide began to turn.  

In early June 1942, just six months after Pearl Harbor, the U.S. appeared to lose another battle in the Pacific at The Battle of the Coral Sea. However, while the U.S. Navy lost more men and ships than the Japanese, it was not the decisive victory many had expected because the U.S. had managed to protect Port Moseby and secure supply lines to Australia. Meanwhile in Europe, while the Allied Forces hadn’t secured any major victories, the Germans were exhausting countless troops and supplies attempting to invade Russia. 

In both cases, “draws” in the Pacific and European theaters proved to be better outcomes than most had expected and the markets sensed it.

HOW MARKETS BOTTOM

Many like to think that markets bottom when good news arrives or when the coast is clear, but this just isn’t true. Instead, as Biggs explains, 

“The bottom of a bear market, by definition, has to be the point of maximum bearishness -- from that point, the news doesn’t actually have to be good, it just has to be less bad than what has already been discounted into stock prices.” 

We saw it in World War II (see chart below) just as we saw it in the early 1980’s (e.g., inflation stopped going up, as opposed to going down), the 2008-2009 Crisis (e.g., banks started losing less money as opposed to making money and house prices stopped going down as opposed rising), and we will likely see it unfold this way again today. 

Dow Jones Industrial Average (1935 - 1950)

Biggs, Barton, “Wealth, War, and Wisdom”

Two Months Ago

Fast forward to 2020. 

This past January felt a bit like 1939-1940. While many Americans were aware of the Coronavirus threat, they largely viewed it Asian and European issue. Rationalizations for why it wouldn’t affect us were rampant. Similar to the Lend Lease Act in WWII, government actions were limited to sending epidemiologists to “hot spots” and providing resources to the WHO and other similar governmental organizations. 

February felt a bit more like 1941. The U.S finally acknowledged that the virus was spreading faster than expected and that the threat was real. The Trump Administration restricted travel to and from China, infections outside of China started to rise, deaths started to pick up, and additional travel restrictions were enacted. 

March has been our Pearl Harbor. After a spike in potential cases, the Trump Administration declared a state of emergency, the CDC recommended social distancing, and regions of the country went into lockdown. As things stand today, nearly 25% of the country is in full lockdown, Congress just passed a massive stimulus package, and the economy has grinded to a halt. Americans are scared, confused, and uncertain. Pessimism is finally rampant and widespread. 

But here is the thing. Much like in the two years prior to Pearl Harbor, the equity market has been telling us this for weeks. International equity markets cracked in late January and the U.S. equity markets began falling precipitously shortly thereafter. As things stand today, the S&P 500 is down close to 30% from its highs, which represents the fastest sell-off of this magnitude in history. Said another way, the market is once again ahead of the situation “on the ground”.

Where Does this Leave Us?

In World War II, the market did not bottom when the U.S. and the Allied Forces stormed the beaches at Normandy in 1944 or took the island of Iwo Jima in 1945 (Wednesday was the 75th anniversary). They bottomed more than two years earlier when World War II was still very much in the balance and pessimism was at its nadir. 

Today, look for a similar pattern to emerge. One example is the correlation between lives lost and where the market bottoms. This is a painful reality, but as seen in the chart below, the U.S. and the world saw five times as many deaths in WWII after the market bottomed than before. The same will likely be true in the case of the Coronavirus. 

Wikimedia

However, unlike a World War, this Coronavirus situation will likely unfold over weeks and months instead of years. This said, while it is impossible to know when this virus will peak, when the human death toll will fall, or when we can declare victory against this invisible enemy, one thing is for sure. If an investor waits for a “when” moment, the market will likely be well ahead once again.