Market insights and analysis

How dynamic, risk-managed investment solutions are performing in the current market environment

4th Quarter | 2021

Market insights and analysis

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Updates on how dynamic, risk-managed investment solutions are performing in the current market environment.

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When I was a kid, it seemed that Good Friday afternoon was always the same. The spring sunshine of the morning would be transformed into a cloudy afternoon. This Good Friday was no exception. Yet, as I sat looking out from my backyard deck on Friday afternoon, a small patch of blue sky stood out, like a turquoise broach pinned to a cable-knit sweater of multiple shades of gray.

I took the parting of the clouds as a metaphor for what our nation, and the world at large, is now hopefully experiencing. The clouds of uncertainty are still roiling above our heads, but some rays of sunshine are cautiously peeking out from the gloom.

A brief break in the clouds: encouraging virus statistics

The present source of hope comes primarily from the cause of the uncertainty—the pandemic itself. Optimistic data we are seeing regarding the growth rate of cases, hospitalizations, and deaths in many of our nation’s hotspots (such as New York and here in Michigan) seem to show the numbers have peaked, stabilized, and in some cases begun to fall.

At the end of last month, my weekly Market Update included an image from the Institute for Health Metrics and Evaluation COVID-19 model. It showed that the likely peak of daily deaths in the United States would probably hit about 2,300 and occur on April 15. Since then, the April 9 model update has changed and now says the estimated peak of daily deaths topped out at 2,035 and occurred on April 10.

Total deaths from this first round of the virus were estimated at the end of March as being around 100,000. Now (April 13 update) the projection is closer to 70,000, with the most optimistic estimate being around 30,000.

More storms on the way: unemployment, uncertainty, and economic reports

Of course, the governmental policies of social distancing and business shutdowns are garnering most of the credit for the earlier-than-projected turnaround and lower-than-estimated loss of life. Yet, as I pointed out in my article last week, these policies for containing the virus, while necessary, are creating a catch-22 dilemma as they also bring the prospect of the worst recession since the Great Depression closer to reality.

Last week, another 6 million of our fellow Americans made their initial claim for unemployment, bringing the three-week total to over 17 million. Just four weeks ago, it was less than 250 thousand. The number could easily grow to over 30 million. JPMorgan economists announced recently that gross domestic product could shrink a mind-numbing 40% in the months ahead.

Despite promises of $8 trillion in aid from the president and Congress, and trillions more in support from the Federal Reserve, Americans remain the most uncertain that they have been about their future in the last 25 years, as measured by the Baker, Bloom, and Davis U.S. Economic Policy Uncertainty Index:

No other event during that time has created as much uncertainty for our citizens as COVID-19 and its impact.

And, unlike the virus news, economic news is not likely to be the beam of sunlight appearing from a break in the clouds in the near future. Rather, as I pointed out a month ago, economic reports are expected to be horrific, at a depressed level beyond anything any of us have ever experienced.

As I said then, we will need to seek solace in what I hope will be a constant overestimation error. Each time we fall short of the projections for these reports, it will provide an instant injection of hope for a quicker turnaround.

The earnings reporting season starts this week. We will be looking backward at the first-quarter revenue and earning experiences of thousands of companies over the next six weeks or so.

While the first two months of that lookback are likely to be positive, the March numbers for most of these reports will probably be so brutal as to bring three-month totals to much lower levels than those experienced in the fourth quarter. One can hardly imagine what the second-quarter reports will look like in July.

Yet, here too we may find a bit of sunshine in the contrast between what is forecast by earnings analysts and what is actually reported. In the past, we have noted that when analysts are overly negative, earnings reports have tended to be better than expected and stocks have rallied. As the following chart of analyst gloom discloses, forward guidance on earnings has never been worse:

Last week, the markets were definitely looking ahead, not backward as the earnings reports will be doing. The result was the greatest weekly rally in stocks since 1974, and one of the best of all time.

It’s time to look ahead

This is a lesson we as investors seemingly have to relearn repeatedly: The financial markets are always looking ahead. The news of the past, whether from economic or earnings reports, does not steer the future course. That would be like trying to steer a car by only looking in the rearview mirror. While a glance backward is helpful in relatively positioning the car, and the markets, it does not tell us anything about the ultimate destination of either.

Rather, a look at a map can be more helpful in determining where we are going. Perhaps one chart we should be looking at is the one that shows the path through the Spanish Flu market of 1917–1918:

Like the present market downturn, stocks fell over 30%. Perhaps reflecting the speed of communications today, our downturn occurred in one-sixth of the time that it took for the decline that commenced just over 100 years ago. In terms of duration, it was more like the plunge from the then all-time high in November 1916. It just was more severe.

After the week of gains we had last week, we have to ask ourselves, have we just rallied like we did from the February 1917 lows, or are we instead spiking higher like we did following the December 1917 nadir? The former rally was followed by a sideways market and one more plunge, while the latter was destined to fly unimpeded through largely blue skies for many years to come.

In either case, note that the extent of the decline meant that it was almost three years before the November 21, 1916, highs were surpassed. After all, given the mathematics of declines, the 40% damage experienced thereafter required a 67% rally to restore the losses.

So far, the S&P’s maximum loss has been 33.7%. That requires about a 50% gain to return to the old highs. That’s why, despite experiencing 10%-plus rallies two out of the last three weeks, the S&P 500 remains about 17% below its February record high.

Fortunately, the FPI strategies that have sustained losses since the February 19 top have generally lost less than the S&P 500 Index. As we have reported, for the first quarter, our average loss was just over 5% and all but three of our 100-plus Strategic Solutions strategies and risk profiles did better than the S&P 500 Index. In contrast with the S&P 500 losses, a number of strategies actually registered profits, after maximum fees, during the quarter.

Note: A 5% loss requires only a 5.26% gain to return to breakeven. The S&P 500’s current 17.3% loss requires another 21% gain to reach that level.

Preparing for whatever the weather brings

While patches of blue sky have appeared in the outlook for the pandemic, and in the recent performance of the stock market, the skies over our nation remain cloudy. A storm in the form of worse-than-expected economic and/or earnings reports can blow in at any time. And the catch-22 dilemma remains: loosen the restrictions on our lives and a new wave of infections could begin; tighten (as has been done here in Michigan) or even retain the restrictions and the economy may stumble into a depression.

Until that dilemma is successfully resolved, we won’t know if the patch of blue in an otherwise cloudy sky will expand to the horizons, or if we will have to continue to deal with the lightning and thunder brought on by the COVID storm. Rest assured, our dynamic, risk-managed approach to investing is designed to provide shelter for investors if the weather proves stormy once again.

My staff remains healthy and continues to be available to provide whatever assistance you may need to weather this storm. They join with me in our hopeful prayer that each of you remains safe and healthy as we wait it out.

Thank you to all our first responders, the heroes of this natural disaster—whether they are growing and processing food, manufacturing needed supplies, providing supply-chain transportation, keeping our pharmacies and hospitals open, providing security for our population, or standing on the front lines of the medical fight to save lives. And our prayers go out to our leaders who have to somehow solve the catch-22 dilemma in the days and weeks ahead. May they decide wisely.



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