Market Update - COVID-19 Black Swan

Marilyn Brohm |
Categories
stock market

I hope all of you are safe, healthy and keeping sane in these unnerving times. Yesterday we notified all clients of our contingency plans to work remotely for the foreseeable future. Our contingency plans have been implemented. We do not anticipate any disruptions to phone calls, meetings or money movement. 

Please know we are focused on your investments and financial well-being. We are in uncertain times, and we are here for you. Please do not hesitate to contact us. 

Black Swan /ˌblak ˈswän/ -- A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences.

What a difference two weeks can make. In my last market update email on March 10, economists and investors were hoping the economic effects of COVID-19 would be short-lived, and a “V” shaped downturn and recovery was possible. Though it is still possible for a fast recovery, most economists are now predicting a sharp recession accompanied by a longer recovery… or “U” shaped recovery.

Investors of all stripes have awoken to the possibilities of a prolonged period of self-quarantine, substantial layoffs and a recession. Restricting human contact for far more than a couple of weeks now looks probable and will harm our economy. Thankfully, the U.S. Federal Reserve has stepped in with a forceful range of responses to help keep financial markets functioning. Plus, central banks around the world are trying to combat the self-imposed slowdown. Beyond this though, massive government spending is the primary tool at this point to help mitigate the economic fallout. Thankfully, the U.S. government is poised to pass a spending bill to help families and small businesses navigate these difficult times. Most economists, and even some politicians, believe the current bill will not be enough, but it is a good start. Unfortunately, more money will need to be spent, and more quickly, to prop up the U.S. and global economy.

The range of outcomes for our collective health and economy are seemingly wide at the present moment. Though I firmly believe our economy and portfolios will recover, both may take months to a few years to do so. As we have said over the past two years, the possibility of a bear market was rising, given the degrading financial conditions (e.g. too much corporate and government debt, along with the limited ability to substantially cut interest rates to help stimulate the economy). However we, like the rest of world, did not foresee an economic and financial contraction due to a pandemic.

At this point, we expect the economic pain to increase over the next three to six months. Financial markets may start to rebound before the recession is over, but we expect the stock market to fall further from here. While we hope COVID-19 is quickly brought under control and life soon returns to normal, we are advocating caution since the length and severity of the virus and its effects on our global economy are highly uncertain.

Collectively as humans and Americans, we will no doubt get through this, but it will take time. Life will return to normal. However, how COVID-19 plays out is uncertain, and I view it as my job to prepare all of us for the possibility of a longer-than-anticipated downturn, if it materializes. As mentioned before, we have discussed the possibility of a bear market and have developed client-specific game plans should a downturn occur.

What follows is some general guidance for all of us during these uncertain times. After this, I will go into more detail regarding the virus, economy and financial markets.

Also, the Raymond James video from Monday is well-done. I would encourage you to take some time to watch the video. A link to the video is below.

 

General Client Recommendations

Exercising Caution

 

For those clients in our managed portfolios, you received an email detailing the bond sales. Please let us know if you have questions. 

At this time, as a general recommendation, we are not recommending clients consider selling their stocks after we have already seen them drop 30-40%. While we do expect stocks to remain highly volatile, and probably go lower, it is extremely difficult to time the stock market. My professional experience from 2008/2009 is that some clients will never reenter the stock market after selling out, locking in permanent losses, and those that do reenter the stock market do so after stocks have rebounded substantially. As difficult as it is, we encourage clients to look past the next 6-18 months and focus on the long-term when it comes to investing, and stocks in particular.

For those who are retired:

  • Depending on your monthly income and cash reserves situation, we recommend you prudently preserve cash and minimize portfolio withdrawals if possible.
  • If you do need withdrawals from your portfolio, we will utilize the cash and bonds to avoid selling stocks for the time being.
  • For those of you taking portfolio withdrawals, I encourage you to focus on the amount of cash and bonds you have in your portfolio that will help you fund your withdrawals instead of selling stocks. Many of you have months to years’ worth of withdrawals from your cash and bonds alone, thereby allowing you to not sell stocks while they are down.

For those not yet retired:

  • Depending on your employment and cash reserves situation, we recommend you prudently preserve cash.
  • Maintain a long-term focus and stay the course with stocks. Timing the markets is very difficult, and over time, stocks make more money than bonds or cash… especially now that interest rates are back to zero.
  • For those contributing to 401k accounts, we urge you to continue to contribute and buy stocks while they are cheaper. I will be doing the same.
  • Younger clients should focus on maintaining a cash reserve, managing debt, and investing for the long term.

For those long-term investors interested in buying stocks:

  • As Warren Buffet said, “Be fearful when others are greedy, and be greedy when others are fearful.”
  • Long-time veteran stock fund manager Bill Miller said on March 18 on CNBC’s The Exchange, “I think this is an exceptional buying opportunity. There have been four great buying opportunities in my adult lifetime. The first was in 1973 and ’74, the second was in 1982, the third was in 1987 and the fourth was in 2008 and 2009. And this is the fifth one.”
  • Buying opportunities only come along so often. We recommend breaking up your cash into tranches, so you can scale into the market over two to four buys.
  • It is my best guess that we have not reached a stock market low. However, if you are interested in buying stocks, you need to get your buying game plan in place.

 

Market and Economic Commentary

In terms of the potential economic and financial ramifications of COVID-19, I found the recent 60 Minutes interview with Neel Kashkari, the head of the Federal Reserve Bank of Minneapolis, to be honest, balanced and succinct given how complex and rapidly the effects of COVID-19 are unfolding. 

Brutal Choices

Flattening the pandemic’s infection curve is painful. Global leaders have a gut-wrenching choice. Simply put, do little (or not enough) and have millions of infections and deaths and overwhelm the medical system and potentially cause a national health crisis… or shutter the economy and be forced to help people and businesses “ride it out” with massive government spending, or be faced with a severe recession. This is what the financial markets realized in the past couple of weeks.

I am certainly not a doctor nor infectious disease specialist, but it appears the self-quarantine measures could last for weeks, maybe even well into May or June. This further hurts the economy. We will most likely see job losses on a scale and pace that could rival the Great Recession. Massive government intervention and spending via unemployment benefits, support for small businesses, and potentially direct cash to individuals are required to blunt the potential severe economic damage. 
 

 

 

 

Deteriorating Forecasts

Most of the investment conference calls I have been a part of (T Rowe Price, JP Morgan, Blackrock, TCW, Raymond James, PIMCO, etc.) are now assuming the recovery will not be a “V” shape, but a “U” shape. In the past week, many economists have made dire predictions about the sharp drop in our economy in the second quarter. Some forecast a rebound in the third quarter, while others assume a recovery will not occur until 2021. 

Though economists are often collectively wrong (read: can’t predict recessions) and everyone is guessing about how this will play out, the fact remains is that no one knows 1) how long it will take to contain the virus, 2) when will life return to normal and 3) how long it will take to develop and disseminate a vaccine to the U.S. and world (12 months at a minimum is what I have read). 

I am optimistic we will beat COVID-19, but I believe caution is warranted at this time since we are on the front-end of the outbreak.

 

 

Painful Stock Market Records

It took the S&P 500 only 22 trading days to fall 30% from its record high reached on February 19, making it the fastest drop of this magnitude in history, according to data from Bank of America Securities. Also, the level of volatility is unprecedented, as we saw eight consecutive days of 4% swings in the U.S. stock market for the first time ever. 

As of Monday, the U.S. and global stocks were down ~30-50% from their respective peaks. Tuesday brought a large uptick in global stocks (about +7-11%) due to the stimulus bill the U.S. Congress appears close to passing.

I hope we are forming a low in the stock market, but we believe caution still is warranted given that we are still in the early stages of battling COVID-19.

Timing the bottom of the market is pretty much impossible. For long-term investors, it is difficult to rationalize selling stocks since it will be very difficult to time reentry. Usually, the stock market moves upward before people deem it “safe” to return to stocks.

Timing when to buy stocks on the cheap is also hard. However, for those who are interested, we again recommend to be ready in the coming weeks/months to invest in stocks. It is always hard to buy stocks when fear is peaking. However, as long as you believe our country and economy will recover, this will be a buying opportunity.

 

 

 

Bond Market Freeze

Financial markets often move in cycles, and one of them is the debt cycle. The U.S. mortgage debt cycle ended in 2008/2009. The corporate debt cycle looks to be ending in 2020. We have spoken about this in almost every client meeting the past 2 years.

Over the last two weeks, the bond market, which is substantially larger and more important than the stock market, started malfunctioning. On Friday, I listened to a veteran bond mutual fund manager at a respected firm say most bond markets were not functioning properly (e.g. U.S. treasuries, mortgages, corporate debt, municipal debt, etc.), and he expected it to get worse. This may or not happen given the U.S. Federal Reserve’s recent (and 100% correct) strong response, but the bond market is the “financial plumbing” for the entire economy, and this concerns us... hence the primary reason clients were notified of a bond trades in our managed portfolios.

Thankfully, the U.S. Federal Reserve and the U.S. Treasury have again acted quickly by intervening in several key bond markets. Overall, the Fed has learned its primary lesson from the 2008/2009 Financial Crisis, which is to act fast and with force. We believe the Fed will eventually help calm the bond markets, but we believe the turmoil will continue given that investors are still selling out for cash or U.S. Treasury bonds, still considered the safest investment in the world.

 

Additional Reading

Below are a handful of instructive articles that I have helped me better understand what is going on and what might happen in the future.