The Independent Market Observer

Is the Recent Market Pullback a Good Thing?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Oct 28, 2020 3:05:42 PM

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marketToday, we have another down day in the markets, as the pandemic continues to worsen. So, is it time to worry about the markets again? Let’s take a closer look.

Back to Reality for the Markets

I am not that worried. As I have been saying, markets have been baking in a lot of optimism: that the pandemic was under control, that the economy was healing, and that things would be back to something approaching normal in 2021 (and maybe not in late 2021, but earlier). That optimism drove prices up to all-time highs, which became something of a virtuous cycle. When everything is awesome and stock prices are rising, well, prices should be high.

Those assumptions were always optimistic, though, and what we are seeing now is a reality-based repricing. As such, this drop is both necessary and healthy. Markets should reflect the most likely future path, not the most optimistic, and that is where we are headed. In that sense, the recent pullback—even if it gets worse—is a good thing.

Things Are Better Than They Seem

When you look at the headlines that the markets are reacting to, you have to remember that things are better than they seem. That the medical risks are real and rising is true enough. But it is also true that we know what to do to bring the virus under control. When we start doing it again (which, admittedly, we are not doing at the moment), we will see the infection rate drop again, just as we did in the first two waves. The volatility reflects the risks, but those risks will pass.

When they do, the foundations of the economy and the markets will still remain much healthier than the headlines suggest. I wrote yesterday about how the most reliable indicators say we may be farther ahead in the recovery than it appears. If that is the case, then once we get the pandemic under control again, we could well see markets recover quickly.

In truth, so far at least, they still don’t have much of a loss to recover from. As I write this, the S&P 500 is down about 8 percent from the all-time high. That is not nothing, but we saw a bigger drop in September and a subsequent recovery. We saw almost as big a drop in June and a subsequent recovery. And, of course, we saw a much bigger drop in March and a much bigger recovery. Current volatility can pass quickly when conditions change.

The Upside Risks

Change they might, as there are some upside risks here as well. Markets are well supported by the very low interest rates engineered by the Fed, which has and should limit any downturn. Beyond that, there is good news: the fact that earnings are coming in much better than expected, as well as the upside risks if and when we get more federal income support for the unemployed.

In other words, while the risks are real, they will pass, as we have seen twice before in this pandemic. When the medical risks moderate, the economic and corporate news will still be better than people think. And that is a recipe for continued healthy markets.

None of this is guaranteed, of course. But looking at recent history, any damage is likely to be both limited and relatively short in duration. Keep calm and carry on.

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