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Understanding Relative Value of Assets During Severe Market Crashes

During market declines, it is critical to keep a calm and objective mind. In recent weeks we have seen a sell-off in equities not paralleled in depth and speed since the 1987 crash. When broad-based markets make sharp sell-offs, it is important to evaluate the relative value of bell-weather securities to the S&P 500. This gives us clues to which securities are holding their value.

During periods of real panic, bellwether securities can lead the decline down relative to the S&P 500. In the chart below, you can see the S&P, Apple, and the relative strength of Apple to the S&P with the red indicator at the bottom. When the indicator is rising above the moving average, Apple is stronger than the S&P. When the indicator is falling below the moving average, Apple is weaker than the S&P 500. This represented the real Lehman panic period in the Fall of 2008. In this scenario, Apple was weaker on a relative basis to the S&P 500. This is indicated by the falling red line.

But just a few months later, near the March 2009 lows, we see a completely different picture. In this case, Apple was more robust on a relative basis to the S&P 500. Apple made a higher low when the S&P was making lower lows. This is indicated by the rising relative strength line on the chart.

Now let’s look at the current situation with the Coronavirus scare. If this were a real panic, we would expect to see bellwether securities outpacing the S&P 500 to the downside. However, this is not what we are seeing. Apple is showing an extreme relative strength to the S&P. In the side by side comparision we can see that Apple struggled to make a lower low while the S&P moved lower with ease in the 3/12 lows.

The same relative strength case can be said for Google too. Although Google is not quite as keen as Apple. See the chart below:

Finally, let’s look at the relative strength of J&P Morgan to the S&P 500. JP Morgan showed a substantial spike on a relative basis to the S&P after the announcement of QE4 on 3/12. This relative strength is critical because JP Morgan is a key player because of their direct relationship with the Federal Reserve.

Although the S&P entered a "technical" bear market, it is essential to note that these are unusual conditions. There is every reason to believe the S&P can and will regain the old highs. Remember, in the flash crash, major securities such as Proctor and Gamble traded at single dollar multiples only to recover almost instantly. While this is not the flash crash, I think parallels can be made.

Also, note that there is a powerful stimulatory environment present:

1. Strong February 2020 Jobs Report (Previous 2 Months Revised Higher)

2. Historically Low Unemployment

3. 0.5% Rate Cut

4. $1.5 Trillion Liqudiity in Repo Market

5. QE4: $700 Billion

6. 2nd Rate Cut to Zero

7. Low Oil Prices are Acting as a Rate Cut

8. Low Mortgage Rates are Stimulatory

9. Relaxed Lending Standards

If we follow the history since 2009 we see that the Fed can erase severe technical damage in short order. There were many "V" shaped bottoms that left investors behind as the Fed ramped up "the juice". Consider that just last Friday alone (3/13/20), the Fed bought $5 Billion in Treasuries. The market also made an important low on 3/12/20 when priced in Fed Juice (see chart below). There is every reason to believe that the market will recover.

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