Insights & Thoughts

Market Rx

Mar 20, 2020 | Quarterly Commentary

Many of you have heard us talk about the fact that the stock market regularly goes through periods where it loses half its value. This happens roughly every ten years. The last episode was around 2009-2010 during the financial crisis. Ten years later we have our current situation.

While not exactly a fifty percent decline, this quarter saw stocks, overall, drop by a third in two weeks. In addition, the level of volatility has been unprecedented. We’ve seen multiple days where the market has moved in excess of five percent in a single trading session. Thousand-point swings in the Dow Industrial Average have become commonplace. These are strange times.

None of this is new news to anyone. The real point here is that while some of this is unprecedented, much is not. The reason for the selloff and the level of volatility is something that has never been seen before but the decline itself isn’t unusual. In the twenty-five years we’ve been in business, this is the fifth major decline we’ve experienced, two of which were actual fifty percent selloffs and the other others (including this one) lost roughly a third. The current market environment feels similar to the 9/11 market and will likely play out in a comparable way.

What does that actually mean? I would place market crashes into one of two camps. The first and most serious (50% crashes) are crashes due to fundamental or structural economic problems in the economy. Examples of these would be the financial crisis or the Y2K/tech bubble. In both these cases there was an underlying multi-year problem that lead to a crisis. The other market crashes, usually leading to 30-40% declines, are due to an event. The Coronavirus and 9/11 are perfect examples of these. In these situations, there was an event that seriously impacted the economy and thus affected the markets.

Of the two, you’d much rather have a decline caused by an event. These tend to be much shorter lived and self-correcting once the event is over. We believe the current situation will be no different and follow this trend.

The severity will ultimately be determined by the length of this national shutdown. The government has thrown trillions of dollars at propping up individuals and businesses in the interim, but it can’t do this for long. Outside of maybe grocery stores and pharmacies, the effects of the shuttering of so many businesses and industries will trickle through every sector of the economy. The longer this goes on, more and more businesses won’t be able to reopen, unemployment will remain high, loan losses will mount, and this turns into a multi-year event. This is a scenario where the cure is worse than the disease.

The stock market hasn’t been the only victim. There have also been severe disruptions in the bond market, too. Once the government asked entire industries to temporarily close, there was a massive rush to raise cash. This run on cash was driven by an unprecedented number of businesses drawing down on their lines of credit and selling short-term securities to bolster their reserves in an effort to stay afloat without any revenue. This frenzied selling created a massive disruption, forcing the Fed to step in and act as a buyer for all the sales. We’ve basically entered into QE4 with zero rate monetary policy. Hello 2009.

The stock market impact is surely temporary but the longer-term effect on interest rates is a different story. Our worry is what the lasting impact will be on interest rates and what that means for income investors. If markets like this can teach us anything, it’s the danger in relying on stock market gains for your income.

If there’s a silver lining in any of this, it can be found in the motto that “in crisis there is opportunity.” We found that for a brief period of time before the Fed stepped with their market interventions, there was a sharp spike in yields on corporate debt and preferred stocks. This gave us an opportunity to lock in much better yields with the built-up cash in our client accounts. Prior to this downturn, we’ve struggled to replace the cash flow from our bond maturities. During this time, we were able to lock in yields that we haven’t seen in years. Hopefully this will be a net positive a year from now.


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