by Timothy D. Carkin, CAIA, CMT
Senior Vice President
Kingda Ka at Six Flags in New Jersey is the tallest and fastest roller coaster in the United States. Imagine being on that coaster. After you are strapped in, the hydraulic motors rocket you from zero to 128 miles per hour in 3.5 seconds. You get a chance to laugh with your friend, catch your breath and lower your heart rate as the ride slowly clicks and clacks its way up 45 stories and then slows as you hit the apex, 450 feet above the pavement. Your heart starts racing again in fear of what is to come. Then, the drop … 418 feet straight down. Your stomach is in knots, everyone screams in fear and you keep falling not knowing when the ride will finally stop.
Arguably, the last few years in the equity markets has felt very similar to the Kingda Ka coaster. At the end of 2018, we felt that first rocket turn our stomachs in a knot. It was a quick V-shaped sell-off and bounce back but it was nerve-wracking to some investors. Then came that slow climb up in 2019, when markets were up, and everyone recovered from that strong, but brief, sell-off. Absent December 2018, it’s been nearly a decade since we’ve experienced price movements close to what we’ve seen this week.
And that brings us to this last two weeks. After setting a high on Feb 19, the stock market has sold of 15 percent in near-record time, primarily on the news of the coronavirus outbreak. Investors are reacting like they are in that 418-foot blind drop. Below is a chart of the VIX, or Volatility Index, which measures volatility in the stock market and is also referred to as the “Fear Index.” The market is exhibiting near-exhaustive levels of “fear” right now. Irrational selling pressure can be a sign of the market bottoming.
Source: FactSet
After the Fall
After your roller coaster car falls precipitously isn’t the best time for your partner to turn to you with words of comfort. Absent the virus scare, the stock market was trading at 19x next year’s earnings which was modestly expensive relative to the 30-year average of 16.1x. At the moment, the S&P 500 is trading at 16.5x, close to historical norms. Further, pullbacks are normal and healthy for the market.
If your stomach can’t handle the wild ride of the stock market roller coaster, it’s worth considering how bonds have reacted to market corrections. In the below chart you can see that bonds can act as a brake, slowing the coaster down, and reducing volatility. In the past two weeks, U.S. Treasuries were up 2.5 percent.
Source: FactSet
The fear of the coronavirus is greater than the virus itself at this point, but fear is reality. As with a huge drop on a roller coaster, it doesn’t matter your fortitude or your machismo, you must respect the fear you feel. But one knows that eventually, the coaster will round out and the ride will slow. Time will tell if and when the market bottoms and only in hindsight can you fully assess what you went through.
Week in Review and Our Takeaways
Fears of the coronavirus contagion drove equity markets down 15 percent from highs and the 10-year U.S. Treasury yield to new lows in a flight to safety
Diversified asset allocation reduces volatility during turbulent times