We hope this letter finds you well, and your health is good—both your physical AND emotional health! Since our last blog post on Feb 28, the spread of the coronavirus continues, which should be surprising to no one. As it continues, the precautions to prevent its further spread have ramped up dramatically. If there is a surprise in all of this, it’s how abruptly that “gatherings of people” are getting canceled by governments, businesses, sports organizations, schools, etc. Frankly, this should be viewed as a good thing, that we the people are coming together to fight this together (even if, ironically, that means we are confined and isolated).
So we have entered the “escalation of containment” phase. It’s disappointing to see so many things getting canceled, but the sooner this happened, the better chance the virus will be contained. Surely the stock market’s reaction (more on that in a bit) and the headlines (World Health Organization declares a pandemic) make it seem like all of us will get the virus at some point, so all these containment measures are too little or too late. But consider this: the virus started in China, and it took the government a long while to figure out what it even was, let alone to do anything about it. Once they did, they quarantined the area and they set containment in the rest of the country, as we in the United States are now doing. The result? China’s daily new cases have trickled to nearly 0, consistently over the last week, after peaking on Feb 13. This is a country that is far denser in population, and far less developed in terms of public safety and resources. Although their government has been more responsive than ours so far with regard to testing and quarantines.
At this point, China has by far the world’s highest total cases, at 80,796 (that includes 62,821 who have recovered). If the containment strategy continues to work, the share of its population that will have been infected will remain below .006%. Even in the “Spanish Flu” pandemic of 1918, only one-quarter of the world’s population was infected, and this was without any advanced treatment methods or containment strategies.
The U.S. now has 1,364 confirmed cases. Of those, 38 have died, 15 have recovered, 10 are in serious or critical condition, and 1,301 have only mild conditions. These data are courtesy of https://www.worldometers.info/coronavirus/#countries. It is scary to consider that since 26 million Americans have gotten influenza this winter, and well over half the population received a flu vaccine; won’t it be possible for more to contract coronavirus? In theory, yes. Throw in the lengthy incubation period (14 days, although it might be 20 or more days) and the death rate of 3% versus 0.1% for influenza, pandemic sounds like a more apt description. This is why the containment strategies are necessary.
We are hopeful it will not come to that, but only because of the seriousness with which the world is taking this, which is totally and completely unprecedented in the history of the world. We don’t want to hang our hat on spring’s warmer weather, or on a vaccine coming to market, although both might also do their part to end the spread.
Now, to the business of business. Perhaps the most apropos line we have heard, as far as the economy goes, is that “the remedy is worse than the disease.” As we wrote in our blog post February 28, there will be a period in which our economy contracts as the U.S. deploys containment. The only question is how long it lasts. The classic definition of a recession is two quarters of negative growth. So if the economy contracts for 6 months and then bounces back, is that much worse than if it contracts for 5 months and then bounces back?
The market is concerned about the likelihood of a recession, but the panic selling is becoming irrational. On days like the last 2 days, investors are dumping even the safest, highest-quality, recession-proof stocks. Look no further than J&J, down $16 (12%) in the last 2 days. Ditto Wal-Mart, which had held up as a relative winner, down $15 (13%) in the last 2 days. Suffice it to say, panic sellers are selling everything…although our core stocks are outperforming the market handily. Even gold is down 4% today!?
To be sure, there are obvious losers from this unique situation: cruise lines, hotels, rental car agencies, airlines, aerospace, restaurants, and entertainment venues. The secondary industries which will hurt include energy, banks, industrial companies dependent upon capital spending, and companies with too much debt. Winners include consumer staples (toilet paper is the new bitcoin!), food retailers, online retailers, diagnostics, pharma, technology plays on working from home, and higher-quality companies. Companies importing from China have seen sporadic supply disruptions, and will continue to for a while, but most factories have resumed production in China. In fact, just today, Foxconn (which is Apple’s manufacturing partner in China) said it had returned to normal production and its suppliers have also returned to normal. Surely a lot of companies who were offline will now be working overtime to restock inventory into the supply chain.
Treasury bond yields have plummeted as investors crowd into safe bonds. The 10-year treasury yield is down to 0.66% this morning, down 0.20% from yesterday, after yields surprisingly rose yesterday. The TLT (an ETF which holds long treasury bonds) has had its best and worst day ever this week alone, up over 5% on Monday and down over 5% on Tuesday (remember that bond yields drop as bond prices rise, and vice versa). Just to highlight how “risk-free” long treasury bonds are, the 30-year treasury bond opened trading on Monday at $135. It fell as low as $115 at the end of trading yesterday. That’s a loss of 15%! It had gained a lot before that, obviously, but if your starting point is right now, because you’re wondering whether to panic-sell stocks and move into bonds, that’s something you might consider. Also consider that dividend yields on stocks have never been higher compared to treasury bond yields.
We have ALWAYS told our clients that while you can’t control where the market goes in any time period, you can control how you react to it. Generally, you will be able to achieve your financial objectives, if you follow these simple rules:
- Adhere to an asset allocation and rebalance to it periodically.
- Don’t give in to greed or fear by making bad investment decisions at bad times.
- Keep a withdrawal rate that is limited to your portfolio’s income or a little above that. If you are selling a little principal every year, ideally you will be able to sell the asset that is relatively overvalued. Right now, that is obviously bonds.
- Just remember that this too will pass, at some point.
During the roaring bull market, we took precautions with clients to ensure that everyone has ample liquidity and non-volatile assets to meet future distribution needs. This meant that we were trimming stocks when they became overvalued, rebalancing asset allocations when they became too heavy in stocks, and having more conversations about planning ahead. It’s not the worst thing in the world to sell stocks at low prices, obviously, but one of the major reasons we plan ahead is to avoid the need to do that.
Stocks today are suddenly cheap. It’s tough to try to catch the proverbial falling knife, which is a fantastic analogy for a crashing stock market. You might catch the handle of the knife, or you might catch the blade and end up with some pain and blood. That means that you didn’t exactly catch the bottom of the market, and it continued to go down and you are left with buyer’s remorse. That is an inescapable feeling during bear markets…no buy looks good until the bottom is reached. Eventually, they will look good. Just remember that almost every buy looks good during bull markets, but the best ones were made during bear markets.
The technical indicators that we follow most closely are now in the vicinity of the panic that ensued during the financial crisis in 2008. The VIX (Volatility Index) is most telling:
Now at 75, this is higher than at any time in modern history save for a couple days in October and November, 2008. It’s twice as high as in February, 2018, a stock market correction which was dubbed the “VIX correction” because of how quickly volatility spiked. This observation is not intended to alarm you but, to the contrary, to point out that, historically speaking, this level of panic is almost unprecedented and it’s hard to imagine it going much higher. Stock returns following these stock market panics are, on average, way above average. Note the following table from Strategas. With stocks now down 28%, we have already equaled the average bear market depth for recessions:
As you can see, the average return over the next year is +28% for non-recessionary corrections and +38% for recessionary corrections.
It also must be said that it’s tempting to look at the market and assume that what we are seeing is a reflection of how everyone feels about stocks. To the contrary, most investors, while undoubtedly concerned, haven’t made a single trade in the last 3 weeks. Believe it or not, the market peaked 3 weeks ago, and is already in bear market territory, which is by far the quickest ever to go from record to bear market, by far. It is possible for traders moving billions of dollars at a time to go from bullish to bearish and have a big impact on the market. Then after the market drops, it draws in concerned investors who sell, and selling begets more panic sales. That’s where we are now. But it always, always, always stops at some point. Why? Traders get “too short” and buyers get more ambitious.
No one knows why or how this panic selling will subside, but it will. At some point, there will be “less bad news.” Companies will resume buying back their stock, Warren Buffett will make a declaration, and/or fiscal stimulus will pass Congress, to provide salve for workers and businesses who might need emergency financial relief. Or maybe the new virus case count will drop. At some point, we are highly confident that there will be pent-up demand, from consumers and companies who will be craving a return to normal life.
Until then, the prudent thing to do is buy more stocks if you’re able and willing, but if not, then hanging on and avoiding bad trades is the next best thing.
In conclusion, we at Monarch continue to monitor developments around the spread of coronavirus (COVID-19). Our staff is committed to serving you during this challenging time. We are taking steps to continue to provide the high-quality, expedient service you expect, while safeguarding the health and well-being of our employees and our clients. Please contact us with any concerns or if we can be of assistance.