The past week has been challenging for all of us. Federal and state governments, universities, sports organizations, companies, and school systems all took precautionary steps to help curtail the spread of the coronavirus and COVID-19. Some of these actions haven’t been seen since World War II. In response to the uncertainty, the selloff in U.S. stocks ended their longest bull market in history. On Thursday, the S&P 500 had its worse day since 1987, with volatility spiking to the highest level since October 2008. On Friday, markets made a strong bounce of over 9% (the largest single-day jump since October of 2008), fueled in part by the President’s declaration of a national emergency which will free up $50 billion federal funding for the states to use for tests, medical facilities, and other supplies. 

What We Know

The famous investor, Sir John Templeton, once said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria." Throughout 2019, the U.S. equity market rode optimistic expectations to very high valuations. For almost two months this year, it could be argued that sentiment elevated to euphoric. Suddenly, the headline risk of the coronavirus has changed all that. School closings, government actions, and losing traditions like March Madness impact our consciousness and signify the seriousness of the matter.

No one knew a threat of this nature was on the horizon. Fortunately, due to concerns about over-valuation, we had already positioned portfolios conservatively. We also made a few tactical sells and held back rebalancing to increase our cash position. Taking a conservative stance was stressful. When the market is going up, underperforming benchmarks is not a popular position. However, this positioning has tempered the impact of the downturn to date. It also provides valuable “dry powder” for making purchases at what we believe will be more attractive valuations.

Investment Implications

Where do we go from here?  What do we do now? Neither question has a simple answer. This market reminds us a little of 1987, for the sharp and swift nature of the decline, and a bit of 9-11 just for the sheer shock of its surprise – how quickly it opened the eyes of the Western world to risks that were never even on the radar. But the Financial Crisis of 2008 and Fed-induced selloff in 2018 are the most recent declines, and they also offer stark contrasts worthy of revisiting.
In the fall of 2018, sentiment turned negative over the Fed’s announcement to continue their planned normalization of interest rates and the reduction of their balance sheet in 2019. In December, the Fed statement maintained its plan of two expected rate hikes in the coming year. Stock prices fell rapidly until Chairman Powell announced the Fed’s stance had changed from planned hikes to being "data-dependent." With the announcement, the S&P 500 made an abrupt “V” bottom to quickly surge to new highs after almost hitting the “Bear” threshold of a 20% loss.

While 2008 stays in the back of most investor’s minds, 2018 is rarely mentioned. In 2008, when it became clear that the structural problems of the financial sector and the consumer’s lack of confidence were going to slow down the economy significantly, the market dropped an additional 11.75% (on top of the 45% from the previous top) before it was over. Most investors suffered from some level of PTSD long after the markets began their slow but lasting recovery. The depth of the market’s drop and the recession that followed is reflective of the complexity of the situation and the steps it took to correct it.

The 2018 selloff was an example of a less complicated, single-issue correction. Each time the Fed provided guidance, the market recalibrated its expected impact on earnings and priced accordingly. Subsequently, the 2018 correction became just another confirmation of “buy the dip” mentality that has worked well for the past several years. However, it’s important to note that U.S. stocks dropped almost 20%, simply over the announcement of two planned rate hikes and the gradual reduction of the Fed’s balance sheet. Also important is the fact that stock valuations (as measured by P.E. ratio) at the beginning of both declines were far lower than they were in February of this year.

So, if a planned one-half percentage point hike in interest rates caused the market to drop almost 20%, what level of contraction should we expect from an unknown that has already caused a disruption in the supply chain, travel bans, and a sudden shift to “social distancing”? The same? More? Much more?  Through yesterday, the S&P 500 is roughly down 20% from its all-time high.

Where the market will go in the short-term is anyone’s guess. We don’t want to cause alarm but do want to share our concern that the threat and its impact on earnings/the economy still can’t be quantified. It’s clear that the government at all levels is now taking this very seriously. We just don’t know what steps will be taken and how effective they may be in curbing the spread of the virus or its economic fallout.
Looking Forward

Regardless of what form they take, crises (small and large) have always been absorbed, and capitalism endures. While we fear the present situation has more challenges to come, we believe we are dealing with a transitory event that, once the crisis has passed, will give way to a strong underlying economy and a renewed sense of optimism towards the future.

From that thesis, we intend to observe and react within the framework of a pre-conceived plan. That plan anticipates neither selling everything and going to cash nor believing we can make a single, giant investment at the absolute bottom. Instead, we expect to adjust in phases, as outlined below. Please note, the steps below only anticipate a further decline in markets. We also have plans to act if the situation stabilizes more rapidly, but we will not complicate this letter with those plans.

Phase 1

Phase 2

Phase 3

Phase 4

We hope the detail we are sharing provides some confidence in and understanding of our reasoning in making adjustments. In looking forward, we expect challenges lie ahead. From an investment standpoint, they will likely be stressful. As history has shown us many times, these periods of stress and uncertainty will pass and be looked back upon as an opportunity. We plan to keep that lesson in mind as we strive to advise and make prudent investments for you.

If the COVID-19 situation continues to worsen (unfortunately, we expect it will), we are concerned for your health, as any friend would be. We hope you will take care to reduce your potential exposure to the virus. If you have thoughts or questions about any of the information we've shared, or on any other subject, please don't hesitate to call us. We are grateful you allow us to serve you and your family, and we will continue to make every effort to justify the trust you've bestowed on us.

Your CCA Investment Team


Advisory services offered through Cravens & Company Advisors, LLC, an SEC Registered Investment Advisory Company.  Securities offered through and advisory services may also be offered through, FSC Securities Corporation, an Independent Registered Broker/Dealer.  Member FINRA/SIPC. Not affiliated with Cravens & Company Advisors, LLC.

Investing involves risk including the potential loss of principal. Investing involves risk including the potential loss of principal. International investing involves additional risks including risks associated with foreign currency, limited liquidity, government regulation, and the possibility of substantial volatility due to adverse political, economic and other developments. The two main risks associated with fixed income investing are interest rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risks refer to the possibility that the issuer of the bond will not be able to make principal and interest payments. Investments in commodities may entail significant risks and can be significantly affected by events such as variations in the commodities markets, weather, disease, embargoes, international, political, and economic developments, the success of exploration projects, tax, and other government regulations, as well as other factors. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary.  Therefore, the information presented here should only be relied upon when coordinated with individual professional advice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of FSC Securities Corporation. There can be no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis do not represent the actual or expected future performance of any investment product.