COVID-19 has provided a dizzying reminder of how difficult it can be to predict the future of market movements, and how counter-intuitive those market changes can appear to be.
Why would a typically market-friendly announcement, like the Fed’s reduction of the target federal funds rate on March 3, cause the Dow Jones Industrial Average (DJIA) to drop 786 points? How can the DJIA climb 5,128 points in the three weeks between March 23rd and last Friday when we are still surrounded by so much bad news?
Five years ago we ran an experiment at our office documented in Chip’s blog Jelly Beans and The Wisdom of Crowds. While we saw a wide range of individual guesses of the number jelly beans in the jar spanning from 100 to 4,000, the average of the 95 submitted entries was within 62 beans of the correct number of 652. We had significantly different opinions, but the average of our individual guesses was very close to actual.
Our opinions about the market and what happens next can be significantly different as well. Someone working in the hospitality industry may see a bleak future for restaurants and bars forced to close during social distancing and be convinced that stock prices will take years to recover from their current levels. Another working in construction may see projects moving forward, with strong demand for their services, and expect a recovery to come quickly as social restrictions ease. Both may be right as portions of the economy recover unevenly as we move from shelter-at-home restrictions to a reopened society.
The struggle between differing points of view has been on display with the wide market swings we’ve been experiencing. A 15.25% drop in the DJIA over two days ended March 12 was followed by a 21.30% jump over the four trading days ended Thursday the 26th. All the news is being weighed and measured by different investors trying to determine what stock prices will look like in the future, just as we tried to guess the number of beans in the jar.
While we have seen a recovery of stock prices from their March 23 lows, it’s difficult to know whether this is simply a bear market rally or a price recovery caused by an overall expectation that we have seen the worst of the virus and the economy will be able to begin its climb back to better levels.
On the positive side, larger U.S. companies generally have more reliable access to capital in any environment, and the Fed’s recent decision to purchase bonds will only make it easier for them to finance their operations. Smaller companies, particularly independently owned ones, may have more difficulty finding funds to rehire workers and cover expenses, which is why the CARES Act passed by Congress included payroll loans and other measures to help. Lower interest rates on bonds and money market funds have also made stocks relatively more attractive to investors.
On the other hand, if COVID-19 continues to spread and the shuttering of businesses is necessary for a longer period of time than may be factored into prices today, we may see further drops in the markets.
Which brings us back to the difficulty of predicting the future.
During the financial crisis when the DJIA fell another 86 points and closed at 6,847.20 on March 9th, 2009 things did not look promising. But the DJIA gained 27.98% from its low on March 9 to June 9 before the economic expansion began in July, and another 15.16% between July and October when the year’s highest unemployment numbers were being reported. By December 8th the DJIA has reached 10,285.97, a 50%+ gain from the low.
Unpredictable, unexpected and difficult-to-explain jumps and drops happen with the DJIA, the S&P 500 and other markets represented by other indexes. Markets prices represent the collective opinions of many people, with different outlooks for the future. And as we’ve pointed out in the past, there is a buyer and a seller on both sides of a transaction, and neither one of them believe they’re making a bad decision, or they wouldn’t be making the trade.
Recognizing the bottom of a market correction is easy to do looking back, but in the midst of a pandemic, financial crisis or terrorist attack, it’s difficult to feel confident about the future. That’s why having an investment discipline is so important, and why we believe it’s better to stick to your plan than worry about what happens next.