The Pandemic and Your Practice – Advising Your Clients Through a Crisis

Sandy McIntyre, Capital Markets Strategist

  • The spread of the COVID-19 disease has been transformational for human behaviour and global markets. The temptation is to believe these changes are permanent, but humans have an amazing ability to adapt and solve their problems.
  • The West continues to be shut down, but East Asia seems to be turning the corner. China is restarting its economy, and new COVID-19 cases are falling in South Korea and Japan. The progression of the outbreak in the U.S. is likely lagging by around six weeks.
  • With U.S. GDP down 10-12%, the consensus is that there will be a recession in the second quarter of 2020. However, a massive government stimulus package, exceeding 20% of the country’s GDP, should ensure the recession will be short.

What are the global economic implications?

  • In late February, there were no forecasts of a 2020 global recession. Today it is consensus.
  • It’s clear that the GDP decline in the second quarter of this year will be sharp, but it will not a permanent impairment of Western economic activity.
  • The stimulus being driven through the global economy by both monetary and fiscal authorities is astonishing. As a result of these policies, markets should stabilize in the third quarter and rebound in the fourth quarter.
  • The fear running through the gossip mills last week was depression, however no central bank or government wants that outcome. Hence, massive global stimulus measures will be used to avert a depression.
  • Is the slowdown in the second quarter of 2020 going to lead to a second great recession (the first being the one caused by the global financial crisis in 2008-09)? The most likely outcome is a short, sharp recession followed by a stimulus-driven rebound.

The impact on equity markets

  • We are now in an established bear market. The sell-off does not appear to be retail-driven.
  • The speed of the decline looks like it was institutional and likely margin call-driven due to issues in the repo markets. Risk parity is one of the popular volatility-targeting strategies used by institutions. The March 2020 sell-off was much faster than in 2008 and 1987, starting in the derivatives market and then spilling over into the retail mutual fund and ETF markets.
  • For the week ending March 20, 2020, there was $36 billion in redemptions of mutual funds and ETFs. However, if combined flows of mutual funds and ETFs are representative of mass retail behaviour, as of March 11, 2020, selling of equities had been decelerating and buying of fixed income was still at elevated levels.

Fear is expressed through volatility

  • Perceived volatility almost always exceeds realized volatility. One of the curious anomalies of the past five years is that volatility has become an asset class. Large institutional portfolios are regularly shorting out month volatility for the option time premium and covering when the time premium decays. This stops working when the Chicago Board Options Exchange’s CBOE Volatility Index (“VIX Index”) curve inverts. The VIX Index peaked on October 27, 2008 at 80.06. It inverted into the waterfall decline in 2018, and again into the February-March 2020 decline, hitting 82.69 on March 16, 2020.
  • In 1987, an overvalued stock market started correcting, which triggered “portfolio insurance” strategies in the futures markets. In 2020, an overvalued stock market started correcting, which triggered “risk parity” rebalancing in the futures markets. The common factor was leverage turning into margin calls.

Safety or growth?

  • For decades, I have used the spread between the S&P 500 Index’s earnings yield and the yield on the “risk-free” 10-year U.S. Treasury. When the earnings yield minus the 10-year U.S. Treasury yield is positive, safety is more highly valued than growth. The current spread is close to levels reached in 1974, 2008 and 2011, all major bear-market bottoms.
  • Credit spreads have also blown out hard, reaching levels that in the past have discounted a recession.

Cross-asset class valuations favour equities

  • I like to look across asset classes to find valuation anomalies. Again, I start with the earnings yield of the S&P 500 Index. I take the yield on high yield debt and subtract the earnings yield I can get from equities. There are times when you are well-rewarded for going up the balance sheet to debt.
  • Equity valuations have been hit much harder than debt spreads. We are back to 2011 relative valuation levels.
  • If you are running balanced portfolios, this is a signal to rebalance. Your investment-grade debt is expensive relative to the equity of investment-grade companies.
  • I manage the odds. So, I rebalanced from debt to equity over the past two weeks.

Looking ahead

  • What will the results be a year from now? We may already be late in an established bear market.
  • I use momentum spikes to the upside to raise cash (the upper red line in the chart above). The January 2018 spike is called out on the chart and the February 2020 spike was almost reaching extreme levels. Indeed, the weekend before the current toboggan ride started, I had advised my advisor that I was raising cash.
  • Periods like the past month are extremely rare. Since January 1954, there have been 16,406 trading days, and as of March 20, 2020, in 143 of them the spot market was 22.5% or more below the 200-day moving average (the lower red line in the chart). In 141 of the cases, the S&P 500 Index and its predecessor indexes delivered positive returns a year out from that day, averaging gains of 29.9%.
  • November 2008 was the peak of volatility for the global financial crisis. You had to get through the first quarter of 2009, but a year later markets were up over 45%.


This document is provided as a general source of information and should not be considered personal, legal, accounting, tax or investment advice, or an offer or a solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this document is accurate at the time of publication. Market conditions may change which may impact the information contained in this document. All charts and illustrations in this document are for illustrative purposes only. They are not intended to predict or project investment results. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies.

The opinions expressed in the communication are solely those of the author and are not to be used or construed as investment advice or as an endorsement or recommendation of any entity or security discussed.

Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,” or “estimate,” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what CI Investments Inc. and the portfolio manager believe to be reasonable assumptions, neither CI Investments Inc. nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

Certain statements contained in this communication are based in whole or in part on information provided by third parties and CI Investments Inc. has taken reasonable steps to ensure their accuracy. Market conditions may change which may impact the information contained in this document.

CI Investments® and the CI Investments design are registered trademarks of CI Investments Inc. “Trusted Partner in WealthTM” is a trademark of CI Investments Inc.

©CI Investments Inc. 2020. All rights reserved.

Published March 31, 2020.