Major U.S. stock indexes entered a correction last week due to the spread of Coronavirus (COVID-19). Generally, a market correction is considered a 10-20% decline in prices. A 20% drop marks a bear market. At this point, broad indexes are in correction but not yet a new bear market, although many individual stocks have pulled back considerably more than 20%. What is unusual about this correction is how quickly it happened, in fact it’s the quickest correction in the history of U.S. equity markets. Rather than quarters or months, it took just six trading sessions for stocks to decline 12%. The S&P 500 Index closed at an all-time high not three or four months ago but less than two weeks ago, on February 19. As we accurately wrote at the end of the Q4 2018 correction, markets seem ever faster in their assimilation of news and information allowing volatility to compress into shorter and shorter periods. Similarly, this decline has been swift and harsh, with daily losses averaging 2.1% and even higher intraday volatility than indicated by the daily closing numbers.
There are several possible reasons for the market decline’s precipitousness. One, the intensity of the selloff likely reflects fear that the impact of COVID-19 globally is largely unknown and unquantifiable yet. Another reason may simply be an excuse to book profits after 14 months of nearly straight gains. And more and more, extreme short-term moves reflect algorithmic trading on the part of institutional asset managers.
The graphs below show that the time from peak to trough and the subsequent length of recovery are relevant ways of distinguishing between corrections and bear markets. Unfortunately, it is impossible to know in advance whether a correction will intensify into a bear market. However, corrections historically involve expectations about potential economic weakness or short-term disruptions; bear markets more likely reflect structural changes and actual economic weakness. Peloton’s base case, market outlook calls for correction and recovery, not a bear market, due to the underlying secular strength of the global economy. Furthermore, we believe this correction provides an opportunity and attractive entry point for selective investments in high-quality, strong balance sheet companies.
The nature of the correction has been a topic of rigorous, daily conversation for us at Peloton, as it should be. We debate the sources and probability of the Coronavirus’ economic impact. We evaluate our holdings and client asset allocations in light of sudden changes in stock prices. With regard to individual positions that have declined with the overall market, we seek to uncover any company-specific factors that could undermine our positive thesis on the security. We measure our long-term, fundamental convictions as professional investors against current market action. We ask if there are reasons to abandon our core investing philosophies, processes, and approach.
Our answer to these questions has been no. The risk of poor long-term performance resulting from panic and market timing argues strongly for tolerating the near-term discomfort that comes with corrections. Having structured our clients’ portfolios to match their cash flow needs and investing time horizon means they have the ability to outlast correction periods. We continue to believe that extreme and sudden price dislocations offer opportunities to upgrade to higher conviction opportunities and accumulate more of those securities we expect to hold for many years. Often the best action to take during these periods is no action at all. We’ve never been driven to trade in a reactionary manner. During the last correction we were largely quiet. Last week, however, we began to make selective, active investment decisions to buy and sell securities that we believe will further benefit our client’s investment portfolios and objectives. We continue to look for opportunities to sell into strength and upgrade portfolios, particularly within the technology, healthcare and financial services industries.
Peloton’s collective assessment is that the Coronavirus will have a negative impact on global GDP and profit growth, but that it’s an episodic event and will not result in a sustained downturn or structural impairment to global growth. In other words, what we’re experiencing now is a short-term hit to demand and profits – to varying degrees depending on the company – not the start of a prolonged recession or bear market. Generational low unemployment, record low interest rates, well-capitalized banks, and a strengthening manufacturing sector all suggest that the fundamental economic backdrop remains positive. We are maintaining our discipline because we’ve seen it work time and again over many years. Whether we’re actively trading or not, we are continually analyzing the macroeconomic environment, client positioning, and individual holdings. When you have questions about the investing climate, our insights or specific portfolio questions, please don’t hesitate to contact us.