All substantial market corrections or bear downturns begin with some form of catalyst. Just forest fires have their proximate cause in the carelessness or maliciousness of human behavior, or lightning strike, on dried woodlands – so too must the destruction of tenuous market values always have a point of ignition.
So it was with commercial real estate defaults in the late 1990s, with Japan entering recession at the peak of the dot-com bubble in 2000, and with residential mortgage delinquencies in 2008. So it has been with the global concern over the novel coronavirus designated COVID-19. Something, even an event wholly unrelated to the market bubble, is always the immediate trigger of a meltdown.
And, as I wrote in this space one month ago, well before the ongoing viral crisis took hold of investors’ – much less the world’s – attention. The equity markets (particularly those in the US) were just waiting for someone or something to strike a match.
This is not to minimize the magnitude of the viral threat. It is real and – moreover – is the cause of material supply chain, transportation, tourism and trade disruption that will have a substantial impact on economic activity over the next several months. There is even the possibility of its impacts lasting through the point at which a corresponding anti-viral vaccine can be synthesized, manufactured and distributed in large quantities. And I am washing my hands frequently. But, as with all modern pandemics, COVID-19 will eventually be tamed.
But is it reasonable to believe that equities will recover their inflated value? This is a less certain proposition. (Although the market closed well off its lows on Friday.)
On the one hand, this sell-off has exceeded the magnitude – in percentage terms – of market disruptions observed during the SARS epidemic of 2003 and the Ebola crisis of 2014 (albeit with some delay from the first expressions of US-related fears over coronavirus). But is this an expression of the degree of the present biological predicament, or is it the measure of the magnitude of the bubble that preceded it?
After all, in both 2003 and 2014 equity markets were a mere 30 months and 4.8 years, respectively, from their prior pre-recession highs, and 42% below and 23% above those prior highs, respectively.
The present crisis began with the S&P 500 nearly 13.5 years from, and a whopping 109% above, its last pre-recessionary high.
When news of COVID-19 hit the tape about a month ago, equity markets were about to hit further all-time highs in a rally that was unbelievably long in the tooth – supported (or not) by some of the most off-the-charts valuation multiples since 1929, 2000 and 2008. It stands to reason that the bigger they are (market valuations), the harder they fall – right?
As I pointed out last month, however, there is another enormous difference afoot: While interest rates have been falling for nearly 40 years, we are now in uncharted territory throughout the advanced world. That bonds do not offer returns that move anyone’s longer-term investment needle (other than traders who, if long, have benefited enormously), has produced an environment that can only be deemed investment desperation for those seeking to have their money produce for them.
10-year and shorter interest rates on US Treasuries are now well into negative real (inflation-adjusted) return territory. And while inflation is likely to fall as well, given pre-existing sluggish economic conditions made significantly worse by the pandemic, the US is clearly in the process of joining the majority of advanced nations in depriving savers and investors of positive risk-free returns when lending to their governments.
This leads to the conundrum voiced to me so often by frustrated investors: “what else are you going to do with your money?” Until very recently, for many, the answer appeared to be to wager it on additional valuation expansion in equities. I say valuation expansion because we clearly have not been seeing either rapid economic, nor any broad earnings, growth for over a year that could have justified prices paid for stocks.
The question then becomes, will the even lower rates that this latest crisis has delivered (to say nothing of Fed action to lower the policy rate in order to stabilize equity markets – which will do nothing more than that for the economy at large), (a) reignite and increase the level of desperation that drove money into the equity markets, or (b) be seen by investors as a clear expression of actual, and anticipated further, economic weakness and stifle traffic to the casino that equity markets have increasingly become.
It is difficult for me to expect a complete return to the status quo ante – even as the COVID-19 crisis dissipates. The equity markets were sicker than the virus that knocked them back on their heels. The market’s recovery will be far slower than that of patients infected with the disease.
Dan Alpert is an adjunct professor at Cornell Law School, a senior fellow in macroeconomics and finance at the school’s Jack C. Clarke Business Law Institute, and a founding managing partner of the New York investment bank Westwood Capital LLC. He has been active in investment banking and finance since 1982.