Over the past few weeks, we’ve experienced some of the most difficult financial market conditions in history. In fact, you would have to go back to 1929 to find so many volatile swings in such a short period of time.[i] We believe it was warranted, given the economic devastation that comes with shutting down complete industries and even states, not to mention the stress the short-term funding markets were under, which were similar to 2008, in my view.
The response to this crisis has also been historic. The U.S. Federal Reserve (the Fed) acted first with multiple emergency interest rate cuts and significant support for the overnight lending and dollar funding markets. More recently, U.S. Congress put together a $2 trillion stimulus plan and another $4 trillion in new authorizations for the Fed to supply loans to troubled companies. Many states and companies have chipped in, as well. This should help alleviate concerns about a near-term domino effect of debt defaults amid the current economic uncertainty.
Given the massive bailout and stimulus package from the U.S. government, it’s my analysis that visibility has improved and the worst-case “floor” has been raised. While the market can certainly turn lower in the short term—or even in the back half of the year—as we continue to work through the challenges and response created and/or exacerbated by the COVID-19 pandemic (or if we experience a second wave of infections), I believe that the aforementioned legislation offers a more stable foundation for the financial markets than a week ago.
That being said, I think caution remains warranted. Many pundits are saying that the stock market bottom is in, but I am not convinced of that. We have yet to feel the pain of Q1 and Q2 earnings and broader economic numbers, which I expect will be difficult to stomach. Earnings and GDP will plummet. Unemployment will skyrocket, at least in the short term. Furthermore, COVID-19 has yet to peak anywhere in the Western world, so we do not yet know what the ultimate strain will be on the global economic and health care systems, or when life will return to normal for most. There have been thousands of new cases per day in most nations, including the economic powerhouses of the U.S., Germany and France, as well as smaller countries like Italy and Spain. An extended period of quarantine may be required to halt the spread of the virus, adding to the depth of the economic downturn. While every situation is different, I remind you that even after the government rolled out the TARP bailout package in September 2008, the equity markets didn’t bottom until March 2009.[ii] I hope this time will be different.
But hope is not a strategy. Of course, we all hope the virus is contained and the economy can weather the current stress. However, as long-term investors, we need to look at the reality of what negatives could happen and plan our investments accordingly.
I think the various measures taken by the U.S. government and the Fed help remove the risk of extreme economic devastation, but I am not convinced that it guarantees a quick recovery and that “all systems are go” from here. Not every job or business will be saved. Corporate America needs to de-lever from record-high debt levels. Then there is the long-term impact from this bailout, which could mean higher taxes and a larger U.S. debt load, but that is a problem for another day.
Some U.S. politicians have been discussing the possibility of ending the quarantines to get back to normal life. There is a risk that if this decision is made too soon, there could be a second wave of COVID-19. Should that occur, I wouldn’t be surprised to see an additional leg down in the equity markets around the globe; this wave may not occur until the fall, when temperatures drop. My hope is that many will have built up immunity to the virus, treatment options will be more plentiful and, perhaps, there will be a vaccine available. But hope is not an investment strategy, as previously stated, so we need to be prepared should this situation arrive.
The length of the current crisis will make all the difference, in my view, which will determine how much cash-flow pressure businesses will face and how much of a domino effect the weakest companies will have on the system. The effectiveness of the government’s response, whether it be tax benefits to individuals or corporations or bailouts of entire industries, will also play a huge role.
However, the news is not all bad. In all this uncertainty and risk, there will be opportunities as well. Not only will there eventually be an economic recovery in travel, entertainment and energy markets, to name a few, but there will be new opportunities in health care and manufacturing.
Regardless of what happens in the coming months, American Portfolios is here to guide you through it. Our seasoned team has been through many market cycles, including the Asian Financial Crisis in the late 1990s, the tech wreck of the early 2000s and the 2007-2009 Great Financial Crisis. While history never repeats itself, we often say in the financial markets that it rhymes. This experience is a valuable asset in markets such as these. These are trying times, but we will get through them. We will continue to update you as things progress. Be safe. Be well.
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