We have been awakened to the risks of the coronavirus by an overload of information, and people are reacting. Check-out lines are long and store shelves are bare for essential items. A colleague noted that a pallet of toilet paper was gone within her trip to the grocery store, which included a 35-minute wait for checkout. Events are being cancelled, schools are closing in favor of e-learning alternatives, and social distancing has entered our lexicon.
Similarly, markets are attempting to price in the overwhelming amount of information and the multitude of potential outcomes. The likely path now leads toward a global recession based on efforts to limit the spread of the virus. Although the impact is unknowable, we find this situation similar to a natural disaster. The impact is severe but typically shorter term in nature, with the economy bouncing back. Our current view is that the U.S. economy will experience economic contraction in the coming months but will begin to rebound in the second half of the year. Earnings are likely to be lower, perhaps flat or negative in 2020, and the willingness of investors to take risk will be reduced.
Markets: Absorbing a Tremendous Amount of Information
- The coronavirus started primarily as a supply shock as China made efforts to contain the spread of the virus. However, the issue quickly became a global demand shock as countries across the globe make efforts to slow the spread of the virus.
- Oil prices weakened due to slower demand before plunging 25% on March 9 resulting from a price war that erupted between OPEC and Russia when talks about supply cuts broke down.
- Monetary policy is moving; however, fiscal policy has been slow moving. We expect action, but it can’t come soon enough for the markets.
- While in the background as of now, the Democratic primaries and 2020 presidential election have the potential to influence the path of policy in the future.
Encouragingly . . .
- The coronavirus situation in China has improved dramatically. As evidence, Apple and Starbucks have reopened their stores. The number of newly reported cases in China appears to have peaked. The situation in South Korea is also showing improvement.
- The U.S. economy was in good shape to start the year, providing greater capability to absorb a shock.
- Fiscal stimulus will come in some form to help individuals and businesses. Details have yet to be determined.
- Central Banks, including the Federal Reserve, have cut interest rates over the past year and again recently to stimulate the economy and cushion the impact of the pandemic. While the cuts do not help today, they do lay the groundwork for a stronger economic rebound. We had begun to see the positive effects of prior stimulus before the virus news.
- Capital requirements, since the financial crisis, have been heightened. The banking system has been tested over the past 10 years for a crisis, and all information suggests that banks have the capital to survive a recession.
- Both the Fed and European Central Bank have taken measures to provide liquidity to the banking system, bond and stock markets.
- Having experienced a financial crisis just over a decade ago, Central Banks and governments have tools in place to address the challenges that arise during times of financial crisis.
Portfolios with equity exposure have been adversely impacted by the decline in the global stock market and parts of the bond market. Over the past year, however, our investment process has led us to take action.
- Fixed Income
- Over the past year we have sought to lower risk by reducing exposure to corporate bonds as the yield gained over Treasury bonds made them less attractive relative to the risk taken.
- Investment-grade bonds have appreciated in value in 2020, cushioning the equity selloff in balanced accounts. Where appropriate, we have been taking profits in bonds to invest in more attractive alternatives.
- In January and early February, we were taking profits in stocks by removing overweight positions after the strong gains in 2019. Sentiment was bullish and we believed that prices were ahead of fundamentals.
- We are not broadly selling stocks today based on our view that the economic impact will be temporary, albeit painful. However, we are selectively buying stocks in portfolios that are significantly underweight long-term targets and looking at tax loss selling opportunities to add value while maintaining exposure.
- We are watching the growth in the coronavirus case count in addition to more traditional market signals to more aggressively add to stocks. Markets are not functioning normally today.
- Complements (alternative Investments)
- In portfolios that own complements, we have sought to lower risk in recent quarters by reducing exposure to strategies more sensitive to the stock market in favor of more defensive strategies.
- Complements can be a useful tool to increase diversification and provide an alternative to stocks and bonds in times of rich valuations.
While uncertainty has instilled fear in financial markets and increasingly in our communities, we remain confident that the economy and financial markets will rebound. As hyperbole surrounding the coronavirus-induced economic slowdown becomes more informed, markets will increasingly price assets more effectively and volatility will decline. Until that time, we are positioning portfolios to be flexible with a lower risk profile while awaiting signs to add to risk assets.
We wish you good health and a calm mind. Please contact us with questions or concerns.
by Jason Herried
As Senior Vice President, Director of Equity Strategy and Wealth Portfolio Manager, Jason develops and builds customized portfolio strategies for our individual, institutional and non–profit clients. This includes investment policy review and development, portfolio construction, manager and security selection and performance reporting. Jason also serves as a member of the firm's Investment Committee and leads the Equity Strategy Group.READ MORE about Jason Herried.
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