Photo Credit: Dawn Beattie || A sharp s-curve can jolt us

The only thing more steep than the twist in the s-curve of the progress of COVID-19, was the twist in the s-curve of human action and talk as people tried to catch up with the projected implications of the virus, and likely overshot the mark.

That second s-curve not only affected what human institutions would close, what & how testing would or wouldn’t be done, quarantining, social distancing, and so called economic stimulus that will do little, but it also drove the market. It created the fastest transition from a market high on February 19th to a new bear market on March 12th. That’s 22 calendar days, or 16 market sessions.

It usually takes a lot to move a market from the bravado of the bull market, which takes time to create, but seems inevitable once it gets going, to raw fear. It typically does not spin on a dime, as signs of weakness meet resistance, even if new highs are not being made.

I could make the comment that when valuations are so high, it doesn’t take that much to create a bear market, and in the Great Depression, that was true (42 days, or 30 trading sessions). But in the dot-com bubble it was not so, and valuations were at their highest then. The transition to a bear market there was 353 days, or 242 trading sessions. That’s almost a year.

But what if there is an interruption in credit conditions? Weak entities that require access to the credit markets get knocked for a loop. That was certainly happening in energy names and various companies with junk credit ratings. It not only matters that a company has enough flexibility for an average disruption, but enough for something that can’t happen. As Buffett sits on a big pile of cash, he may still say, “We’re paid to think about the things that can’t happen.” Hopefully he’s deploying some cash now.

I like the companies I own to have low debt levels as a result. Nonetheless, I was knocked around last week by companies that had low debts, but had some economic cyclicality. Personally, I’m not worried about a deep recession, at least not yet. The economy will slow down. Real GDP may even shrink for two or more quarters in a row.

I think that the national and global fears from COVID-19 will relent, and be replaced by modest local outbreaks that may not go away for a while. I also think that the Saudis will eventually return to restricting oil production. The Saudis play games like this, then realize that they don’t work, and so they stop. The Russians may be a little more serious, but they will realize within a year that they are losing as well. A decent number of firms that frack in the US may go broke in that time, but that is a minor effect on the economy.

In other words, I don’t think the two scares are really that scary in the intermediate-term.

I do think there might be some similarities of last week to what happened in October 1987. My only question is where forced selling was going on? Risk-parity funds? Hedging gone awry? Difficult to tell, and I haven’t seen anything definite, but the implied volatility of last week rivaled that of October 2008.

Throughout the week I added to stock positions for my clients and me, slowly, but enough to raise equity levels a few percent. That doesn’t sound like much, but when your equity percentage is falling in a bear market it takes thought to decide where to go when buying amid carnage.

I had fairly high cash positions for the strategies that I run. Though many thought differently, I thought there was an alternative to stocks — cash and high-quality bonds. In the bear phase, they definitely don’t lose as much as stocks.

But at present, stocks are offering more competition versus bonds. My stock model forecasts 5.25%/year returns for stocks over the next 10 years. That’s a lot different than a month ago, when that figure was 2.2%, and the Barclays’ Aggregate had a higher yield.

I’m not going nuts here. I have schedules for stock exposure for my two main strategies, and I will adjust as the markets go up and down. 5.25%/year still isn’t that great, but it was worth adding a little more to stocks, especially as cash yields decline further.

One final note, always worth remembering: the nature of rallies in a bear market is that they are sharp and short, as hope gets overwhelmed by the crisis du jour. When the rallies become longer and flatter, and credit risks seem modest, that is what a bull market is like.

One final note, maybe not worth remembering: when will the marginal buyers of Treasury notes and bills get tired? Now that’s a risk that would really shake things up.