Small and Mid Cap Investing in Volatile Markets


Economic estimates have been shifting wildly, but in the U.S. there seems to be settling for low to mid-single digit decline in the first quarter of 2020, down double digits in the second quarter of 2020, followed by a strong second half rebound that some people have occurring in the third or fourth quarter. Interestingly, the last time GDP was down double digits in the United States for a quarter was the first quarter of 1958 during the Asian flu pandemic, which killed over a million people globally, and 100,000 people in the U.S. Interestingly, over the next three quarters, GDP increased 3%, then 10% and then 10% again. As one of the first data points that have come in to show just how severe this downturn is, initial jobless claims were filed this morning. They come out every Thursday measuring how many people are looking for assistance from the state because they've lost their job. 3.3 million Americans filed for jobless claims in this past week. To put that in context, the old peak was 665,000 in the global financial crisis in March 2009. So, that would represent alone a two percentage point increase in the unemployment rate just last week. I want to talk about sentiment. At Alger, we measure sentiment with a couple of different metrics. One, we like to look at it is the VIX index, which is the implied volatility in S&P 500 options. Some people refer to this as the fear index. Generally it ranges 10 to 20 in a normal market; above 20, say 20 to 30 shows some increased anxiety; 30 to 40 is investors being pretty, extremely anxious; and over 40 I would characterize as panic. It occurs statistically less than 2% of the time. That VIX recently hit a record, even higher than the Global Financial Crisis. And it's currently sitting close to 60, so extremely elevated, showing a lot of anxiety in the marketplace. Another metric we look at is a money market funds, how much cash is on the sidelines. And with investors liquidating a lot of risky, risky assets and piling into cash, those money market funds have surged to about $4 trillion, up over 20% from last year, with the highest weekly inflow that we've ever seen last week, with nearly $100 billion. And that total $4 trillion is up about, at the peak, similar to the peak of the Global Financial Crisis. I want to contrast that with what we see as confidence from executives. Typically we see insider net selling, but right now we're seeing strong insider buying. We're seeing hundreds and some weeks even thousands of

executives buying. In fact, we're seeing the highest insider buying on record, even higher than the Global Financial Crisis. So, in contrast to very skittish investor sentiment, executives seem more confident in their fundamentals of their companies over the longer term. And I point out that historically, there've been historically strong returns after a VIX registered very high levels. In fact, historically, when the VIX has been over 40, the one-year and three-year returns have been 32% and 58% respectively. The next point I want to make is on stimulus. Obviously, there's a lot of stimulus entering the pipeline, both on the fiscal and the monetary side. The key thing to note is that it's much, much greater than it was in the Global Financial Crisis. On the fiscal side, with the Senate having passed and the House about to pass the fiscal bill, the headlines show it is $2 trillion, which compares to the $8 billion stimulus in the Global Financial Crisis. But in reality, we believe the Federal Reserve will be able to leverage some of those funds and turn it into something that's more akin to a $4 trillion stimulus. Of course, that's a very large number relative to $20+ trillion economy. On the monetary side, the Federal Reserve has announced open-ended quantitative easing, buying treasuries and mortgage-backed securities, corporate bonds, and even some ETFs. They've been doing about $600 billion a week over the past week, which is faster than the average that they were doing per month in the Global Financial Crisis. So, a lot of quantitative easing from the Fed. And the European Central Bank for its part is purchasing about $240 billion this week and on track to do €1 trillion in quantitative easing by the end of December. In terms of the virus, we're very focused on the individual country curves. We think that the stimulus is great from a market and economic standpoint, but it's not sufficient to really restore confidence. Investors need to see some kind of deceleration or an ability to project the transmission of the virus. So, we've already seen the transmission slow significantly in some eastern countries, like Korea and China. And we're watching the western countries that are ahead of the United States, like Italy, very closely. So far through today, the new cases in Italy seem to have peaked on March 21st, but of course they're volatile. And that's going to be, I think, a key for the market going forward. We'd expect the United States cases to continue to accelerate because we are at least a week and a half behind Italy.

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