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3 Questions Answered: KAR on Today’s Market Environment

Kayne Anderson Rudnick offers insights on how deep and how long this recession could be, signs that we’re nearing a market bottom, and how KAR portfolios are holding up in this environment.

Equity and bond markets continue their roller coaster ride as new developments regarding the coronavirus (COVID-19) seem to be uncovered on a daily basis. Year to date, small stocks (as measured by the Russell 2000® Index) are down approximately 40% while large stocks (as measured by the S&P 500® Index) are down approximately 30%.

Authorities are doing what they can to help manage the economic downturn. The Federal Reserve is trying to stabilize the bond market, which is a necessary precondition for the stock market to do better, and the federal government is trying to push forward a fiscal response which will be in the magnitude of $1 to $2 trillion in aid.

Recession is starting to be accepted by Wall Street. Morgan Stanley, Goldman Sachs, and other analysts are cutting earnings estimates dramatically and cutting GDP forecasts at least for the second and third quarters of this year. This is actually good news as agreement on recession is almost always a sign that it is time to buy stocks.

So much of this is information that you already know, so let’s try to answer three commonly asked questions that we are receiving today.

1.      How deep will this recession be and how long will it last?

Nobody knows how this will all play out as we are in unprecedented times. However, we believe markets will start to stabilize once cases of the coronavirus outside of China start to decline globally. Once this happens, the fiscal and monetary measures that have been put into place should start to have an immediate impact on the markets. Hopefully this will be in the next month or two, but that really depends on how data on the spread of the virus begins to unfold.

2.     What are the signs of a market bottom that we should we be looking for?

These four things would help indicate if we are at, or near, a market bottom:

      1. As already mentioned, when the number of coronavirus cases outside of China starts to decline, that will ultimately be the most important fact that turns the markets around.
      2. Bond market spreads begin to stabilize.
      3. The small-cap stock benchmark, the Russell 2000 Index, begins to outperform the large-cap benchmark, the S&P 500 Index.
      4. Stocks of heavily indebted companies start doing better or at least stop declining. Heavily indebted companies are really getting hit hard in the current environment, so it will be a positive sign when these types of companies start to improve.

3.     What is KAR doing with your portfolios in the current environment?

We continue to do what we have always done—looking to preserve capital on the way down. We seek to avoid capital erosion over the longer term (typically a 3-5 year period). If we lose confidence in any of our companies in their ability to do that, they will most likely be exiting the portfolios in the near future. Fortunately, we don’t own a lot of those types of companies.

We focus on businesses with low capital intensity and low debt, so they can endure periods like what we are experiencing now. We continue to stay focused on companies that will be able to take market share, dominate their industries, and sustain their competitive advantages over the next 3-5 years. These are the types of businesses that ultimately should be rewarded over time.

The commentary is the opinion of the subadviser. This material has been prepared using sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice or an offer of securities.