Boston - The large gains in the equity trading sessions of March 24 and March 25, with the S&P 500 Index up 9.4% and 1.2%, respectively, have given us a glimpse of the upside potential once market sentiment shifts, and marks yet another leg in the most volatile environment we have seen in years. But the market has plenty to chew on before we can reasonably expect that volatility to abate. Let me touch on a few of the factors:
Public health. The first priority is for state governments to take the initiative to flatten the curve of COVID-19 infections so that people can go back to work. Then, we are likely to see a staged re-entry of businesses and workers rekindling the economy.
Valuations. With the S&P 500 Index still down 27% from its peak, valuations certainly are better. But not everything deserves to be bought, because many companies will not recover, or will bounce back only enough to return something to bondholders and other stakeholders senior to equity in the capital structure.
Stimulus. (for want of a better word) Congress is pegging $2 trillion for bank loans, airlines, small businesses, hospitals, and individuals — it's really a backstop for the unprecedented shutdown of most of the US economy. The Federal Reserve is trying to grease the gears of the fixed income markets, particularly short-term funding, and improve financial conditions.
Watch out for dilution. Recent conversations with our contacts on equity capital markets desks suggest many companies that do not receive federal assistance will need to quickly shore up their balance sheets. Like the banks in 2008 and energy producers in 2016, we expect companies across sectors will need to raise money in coming months.
Bottom Line: Episodes like these alter the economic landscape, which underscores the importance of fundamental research. Avoiding debt-laden companies and focusing on well-capitalized franchises that can survive and thrive requires an active approach — indexes can't distinguish one from the other. Another truism is that markets fluctuate, and I do believe that professional investment management is best positioned to add value when the fluctuations reach this scale.