In our last blog post we highlighted the overbought state of the markets, mentioning that it was hard to put a bunch of money into the market at current price levels because historically we know that markets like to revert to the mean over time. This fact lead to our strategy of taking small bites of individual equities instead of large, full sized positions all at once; and in hindsight we are thankful for the conviction that we felt.
Since Valentine’s Day we have seen the S&P 500 decline roughly 11.5% to today’s market close (March 3rd). Briefly the index corrected more than 15.8% from its recent all time high on February 19th. We didn’t except the pullback to be so drastic or so sharp, but nevertheless this is the type of market pullback we were hoping would occur. Now we find ourselves in a situation of evaluating the shift in sentiment to see if any underlying economic indicators are really flashing caution or if emotions have overtaken the market.
The ISM manufacturing index numbers (an indicator of manufacturing expansion and contraction in the US) showed that February growth still existed. Although growth slowed relatively to January, being pulled down by declines in oil/petroleum production and transportation segments, it shows that the fundamentals of manufacturing are not being swayed drastically yet by the Corona virus. In addition, construction spending for February rose above consensus due in part to an increase in home building and infrastructure spending and January consumer sentiment remained very strong. While we might not yet be feeling the effects of the Corona virus in these US numbers yet, the death rate of the virus is not enough to scare us away from equity markets at this time.
China has been exposed to the effects of the virus and already we have seen an uptick in manufacturing capacity in China. Two weeks ago, according to estimates by Bloomberg, China was operating at 60-70% capacity but is expected to be at 90% by the end of March. This can also be evidenced by Starbucks announcing that they were re-opening the majority of their Chinese locations.
As a precautionary measure, the headline news in today’s trading was the Federal Reserve issuing an emergency 1/2 point rate cut. This doesn’t come as a total surprise because of some of the comments that Jerome Powell was touting last week saying that the virus poses ‘evolving risks’ and that the Fed is ‘closely monitoring developments’ and will ‘act as appropriate to support the economy’. With the new cases being diagnosed this past weekend in the US, it seems the Fed believes they can stimulate economic spending and output before the virus tries to stalemate. We don’t think a rate cut was totally necessary yet, and the effects of this will remain to be seen in future years if the Fed remains on course with the current 3-4 rate cuts expected to happen in 2020. Perhaps this is a temporary cut and we will see the Fed comment so in their upcoming March policy meeting.
Taking in all of the market developments as a whole, we feel fairly confident increasing the pace of equity purchases at this time. As the great Warren Buffet preaches continuously, ‘be greedy when others are fearful’...this is what buying low feels like. Currently, the relative strength index is at 32 (daily) and 42 (weekly) for the S&P 500. If you bought each time the Relative Strength Index was at current levels, you would have reaped approximate returns between 16 and 30% over the coming months and years.