This is not getting any easier to watch, to say the least. The market’s response to the lack of a coordinated government/fiscal plan, coupled with massive industry effects stemming from stopping inbound European flights, school closures, sporting event cancellations, theme park shutdowns, movie delays, the loss of productivity from employees working from home, fear of going out and a focus on the near-term impact is painful and overdone. The market closed again for fifteen minutes on Thursday after a 7% drop triggered the circuit breakers shortly after the market opened. That’s twice in one week. We only had one stoppage during the Lehman crisis. Thursday’s near 10% decline was the worst day since the 1987 crash and we are now down 26.5% in just 15 trading days. The wide bid/ask spreads of illiquid ETF’s, corporate/municipal securities and certain stocks is adding to the uncertainty as pockets of the market are not acting properly due to a demand for cash.
What we need right now is cooperation in DC, and quickly. They seem to have some agreement that should pass both chambers after Pelosi + Mnuchin compromised yesterday. Small businesses must be assured they will not go under after a few months of minimal sales. Hourly employees need guarantees of income and job safety. Further education of the virus and how to handle it would be welcomed. More test kits are coming which will raise the number of cases but lower the death rate. This small bill will help but more needs to be done.
The Federal Reserve will meet next week and we’re all but assured of another sizable rate cut, possibly to 0% again. The announcement of QE4 (or 5 depending on your definition) that helps alleviate stress in the market will help reduce fear. It won’t cure the disease, but the market needs more confidence that actions are being taken. The repo announcement yesterday was massive and a huge help to calm some panicking. Other options include purchasing corporate bonds or stocks among many more ideas. They will need government approval if they decide to bring out the bazooka approach.
All of this will take time. Congress did not move quickly prior to the extreme partisanship of the past 15+ years. Does anyone believe Trump and Pelosi can sit in a room and have a cordial discussion today over something sizable? The left will continue to bash Trump’s response to the pandemic, while the right will point to the low numbers associated with this virus compared to other outbreaks. The truth is somewhere in between but that is not the point. Putting hurt feelings aside and actually getting something real done is critical for both parties. This will be short lived, but those in need have real problems that need assistance.
The Chinese stock market stabilized after the number of cases peaked. That took a little over 3 weeks to occur from the initial ramp in corona cases. We’re finally getting test kits so the numbers will rise substantially in the US. Taking South Korea and Italy’s infection rate, we could have 50,000 – 75,000 cases here in the next 2-3 weeks before slowing down. With new testing abilities from Roche, it is even likely our numbers surpass those estimates. That is about 0.02% of our population and certainly less than the true number as many younger citizens with healthy immune systems did not get tested over the past few weeks. On a positive note, this lowers the death rate. Ideally it will be less than 1%. Still, it is likely 10x more deadly than the typical flu but not as widespread.
Here are the positives from a long-term investor standpoint with respect to the virus:
• We know the genome and how to detect the virus.
• Billions of dollars are being thrown at a cure…it will take time but we will get one. Trials are ongoing, vaccine prototypes already exist and globally, the scientific field is cooperating.
• Cases in China + South Korea + Italy basically peaked in 2-3 weeks. We’re into week 1, almost done with peak fear.
• 80% of cases are mild and the proportion of people that are cured keeps rising.
• Anyone under 50 shows mild symptoms and, thankfully, children seem to be less effected.
None of this is to say we are not in a serious situation. Lives will be lost. Many more will get sick. Families are rightly scared for their elders. This virus looks to be short-term in nature, but the economic picture becomes quite clouded for several months. Small businesses who rely on day-to-day cash flows are in trouble. Travel companies will be affected for an extended period. Funding needs are a concern with an erratic market. Sales functions that typically happen in face-to-face meetings are delayed. Conferences being cancelled hit many parts of the local economies. Most of these events are not fully insured. Money has already been lost with more to come. Tightening of purses will expand. People who rely on tips are in a real crunch as they typically don’t have savings that can last more than a few weeks. Jobless claims will rise. The US consumer, who has carried the economy, will pull back (though, looking at my local food store, they have spent a lot of money this week alone).
Let’s take a look at the positives from this point forward:
• A 27% drop from the peak, prices in a lot of bad news, probably too much from a true economic standpoint. When you see world class companies like #Proctor & Gamble drop nearly 30% in a few weeks, you know mass liquidation from “fear” is taking hold instead of fundamentals.
• Central banks are attacking this with increasing power. The Federal Reserve’s balance sheet could now double by the end of the month if the repo operations keep needing them to assist in providing a backstop. They already offered over $500B, with more to come. This helps alleviate some of the cash needs and stress in the cash/credit markets.
• Interest rates are at all-time lows. In a few months, when everything is back to some normalcy, the ability to take on or refinance debt at such low levels is the perfect kindling for a ramp upwards.
• Mortgage rates are a massive boon to the consumer. Refi activity is over 4X that of last year. The amount of money that can be saved via 30-year mortgage rates being adjusted lower is estimated to be $42B on an annual basis. That’s 0.2% in US GDP.
• Valuations are back to historic norms. If we take 2020 estimated earnings and simply push them to 2021 with a slight discount, the market is down to a 15 P/E. That is in line with history, but would normally coincide with a 6% ten-year Treasury. We’re at 0.75%.
• From most estimations, this virus will subside in the coming months. A shot should be developed over time. If you were going to buy a car or an iPhone, your purchase is delayed, not cancelled. The economy could experience a U-shaped recovery over the coming quarters but the stock market will sniff this out and get a V-shaped move.
• Dividends are very attractive today. The S&P yield is up to 2.2%, 140bps above the 10-year Treasury. If you can look out the next 10 years, you can buy a basket of world class stocks such as #VFC, #MRK, #KO, #BMY, #AMGN, #DLR, #CVS, #TXN, #K, #MMM, #UPS, #T, #VZ and #KEY with an average dividend yield of 3.5%, and growing. The likely outcome is that basket handily outperforms bonds while providing income levels double that of a fixed income portfolio.
• The previous market corrections such as EU Debt Crisis of 2012, Yuan/Commodity of 2016 and Christmas Eve of 2018 from too much Fed Tightening all led the S&P to touch the 200-week moving average. They also proved to be decent entry points. We’re about 10% below the weekly average today. Risk/reward has improved greatly for long-term equity investors.
• Pre-market news: Yesterday, #Disney announced they are closing their US and Paris parks yet the stock is up ~7% in early trading. It’s not the news that matters but how the market reacts. This is a really good sign that the worst may be behind us.
The exact bottom may already be here but we do not have the full all clear signal yet. More positive signs from Governments around the globe and a slowdown in the number of cases would be the next impetus to get aggressive. Pruning some laggards with balance sheet issues and improving the quality of your portfolio still makes sense here. Taking some tax losses and moving to a company with solid 5+ year prospects should be rewarded.
We don’t know if this is the exact bottom but with a 27% drop, at least we know we’re close. If you have excess cash, nibbling here may be wrong for a few days/weeks but right for a few years. Trying to call the exact bottom is foolhardy but dollar cost averaging strategies typically work out after drops like this. Great values are already out there. Put excess cash to work, but keep some powder dry for later. Your asset allocation likely has too much fixed income now. Swapping some bonds for equity to get back in line with desired ranges should work out.
Most of all, stay safe. Keep your elders away from crowds. Pick up their groceries from the market. Stay home if you feel ill. Help out your local charities that need funds. Reach out to family members who may be cash stricken. Obviously, wash your hands frequently. Most of all, don’t panic. We will get through this. Together, we can all make sure this isn’t a widespread disaster. Hopefully, this is short-lived and we can get back to a normally functioning society by the middle/end of Spring.
On this Friday the 13th, rapper Common turns 48 and actor William H. Macy turns 70.
James Vogt, 610-260-2214