I received a text last night asking a pretty good question; one that I thought others might be wondering about as well. The text read, "Dave, we knew the news was going to be bad, why does the market suddenly care?"

From my perch, the answer is based on the concept of "expectations versus reality." On Friday, there was hope that things on the virus front might not be as bad as projected. Maybe we really can flatten the curve. Maybe we've overreacted. Maybe things will be okay quicker than expected.

After all, stocks were bouncing. Folks were saying the low was in and that the worst was in the rear view mirror. In short, warranted or not, there was some hope creeping in. And then yesterday, there was some pretty darned good news on the testing and vaccine fronts, which helped stocks continue to advance in the early going.

But, today is a different day and the DJIA opened up down big again. And we're back.

Another Playbook to Follow

I think the best analog to follow here – besides the Crash Playbook, that is – is the "War Playbook." Prior to a war beginning, the market tends to freak out due to the economic uncertainty. But once the war gets started, the market tends to trade based on how the war is going.

In this case, the war that Wall Street is focused on is against the virus and the resulting economic impact.

Exhibit A: Yesterday, the market traded higher on the ABT/JNJ news about tests/vaccine trials. But then Governor Cuomo said the virus is turning out to be "more dangerous" than we thought. Stocks then sold off for the remainder of the day. (It is also worth noting that the "rebalancing buying" ended yesterday.)

Today, we have Trump's "Hell of a two weeks" quote and the projection from the White House that between 100,000 and 240,000 Americans will die from the virus. And given that there are currently "only" 4090 deaths so far in the U.S., this represents a classic case of "worse than expected" news. Thus, it appears that stocks are now trading on "how the war is going."

Expectations Are a Moving Target

The key here is to figure out what the market is "expecting" and, in turn, what has been priced in. My thinking is that the -35% decline from high to low is likely sufficient to "bake in" the idea that the economy will remain shuttered through April. However, if the SIP (shelter in place) orders need to be extended into May (or beyond), there could certainly be some additional downside ahead as stock prices factor in new "expectations."

Don't Forget, There Are 3 Problems Here

While I am a card-carrying member of the-glass-is-half-full club, it is also important to remember that there are really three fronts to this war. First, there is the virus. Next is the record-breaking plunge in oil (and the associated damage to the oil patch and second derivative firms). And finally, there is the problem in the credit market – specifically, the lower tranches of investment grade corporate bonds (which, of course, aren't really investment grade anymore).

Currently, the credit problem looks to be on the back burner. The Fed put a stop to the immediate crisis by announcing they were going to start buying corporate bond ETFs (LQD) and muni bonds. However, this doesn't really "solve" the problem. It just means that "mark to market" avalanche hasn't begun. So, while the Fed may be able to hold this problem off, it remains something to be aware of. And in the meantime, I for one have NO interest in corporate bond funds or ETFs.

It is my sincere hope that this quick missive is helpful and that all reading are staying safe and healthy.

Thought For The Day:

"How poor are they that have not patience! What wound did ever heal but by degrees?" — Iago, in Shakespeare's Othello

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: ABT, JNJ - Note that positions may change at any time.

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