Looking back to January and early February this year, investing looked easy. It seemed like the market hit a new high just about every day. Investors shunned bad news certain the Federal Reserve backstop would keep risk and loss at bay, maybe forever. What a difference a month makes. March ushered in a frightening new normal as the COVID-19 virus changed the way we live and work, and the way the economy and markets operate. And as important as money is to many of us, the health risk of the virus pandemic far outweighs concerns about investment returns. Faith, family, and friends have become a singular focus for many.
For 36 years, our mission at WBI has been to help clients be more successful as investors by creating outcome-based portfolios focused on protecting and growing capital. By actively managing portfolios to reduce capital loss during bear markets, we hope to provide investors with a comfortable and successful investment experience. The math of market returns clearly illustrates that investors should never take significant losses if they can prevent it.
Unfortunately, investors are taught to try and buy and hold which can expose their capital to devastating losses. As they see their account balances dwindle, investors tend to bail and fail, selling low to protect remaining capital and then sitting on the sidelines for years afraid to reinvest as markets recover.
We warned the markets were egregiously overvalued based on outright Fed manipulation of the markets. We suggested investors stop chasing returns and instead move to protect capital in the event some exogenous incident torpedoed market prices that were buoyed by excessive optimism. March’s bear market declines have ended the longest bull market on record. If the bloody rout in equities was not enough to create anxiety in the stoutest investor, the unhinging of the U.S. Treasury market was sure to instill fear. As central banks and institutional investors around the world moved to cash to deal with the fallout from the virus, bond markets ceased to function rationally. Luckily the Fed in the U.S. and other central bankers worldwide have been quick to lower interest rates and pledge unlimited QE (quantitative easing) support to restore normal market function. However, the unknown factor here is just how bad the economic fallout will be from the forced shutdown of economies around the world as whole populations quarantine or shelter in place. There is no modern parallel to provide context for a full stop in economic activity for months on end. Market reactions are likely to be quite severe and resemble a massive roller coaster ride. Temporary relief rallies followed by successive market declines are apt to make investors nauseated as losses pile up. We think the ardent hopes for a “V-shaped” recovery are wishful thinking. The economy is much more likely to recover with fits and starts as millions of small businesses struggle to survive, and unemployment remains higher for longer.
The silver lining of the COVID Crisis is the government’s fiscal stimulus response, which has been sorely lacking and much needed to lift the economy out of the doldrums created by the Financial Crisis of 2008. Between the excessive monetary policy support by the Fed and the trillions of fiscal stimulus the government has offered, we could reinvigorate the economy enough to achieve more normalized growth rates averaging 3-5% or more. So far, we have seen a massive $2 trillion stimulus package approved to provide short-term relief to consumers and businesses. While I applaud the Administration and Congress, government agencies do not have the infrastructure needed to deliver such a massive amount of aid immediately, which is necessary to forestall an economic calamity. It’s likely to take longer to “grease the skids” than would be ideal under the circumstances, but I believe the government and Fed are on the right track.
I’m most excited about the next fiscal stimulus package that promises $2 trillion or more for longer-term infrastructure projects like rebuilding America’s crumbling bridges, roads, and tunnels, as well as upgrading transportation, air travel, power and water systems. We have been writing about the need for infrastructure financing for more than five years. Yet I believe we are going to need even more stimulus to address cybersecurity, advance technology infrastructure, and develop crisis response systems so that we can not only protect ourselves from cybercrime but be able to better respond to the next crisis. The combination of the Fed, Treasury, Administration, and Congress working together on behalf of the public good for the first time in almost 20 years is nothing short of breathtaking! I believe when Americans come together as one people and one nation, there is nothing we can’t accomplish.
So what comes next for investors? That is the “trillion-dollar question.” While this situation is far different than any I’ve seen in my almost forty years of experience, the abrupt shock to both the economic demand and supply is reminiscent of The Great Depression. There are some parallels to draw from to guide investors forward:
1. We have likely not yet hit the bear market bottom.
Unfortunately, the fear and uncertainty surrounding the spread of the virus and the risk to life for thousands of U.S. citizens are going to weigh heavily on consumer and investor sentiment. In addition, unemployment is likely to soar to levels not seen since The Great Depression. Deterioration in economic statistics and corporate profits, or more accurately losses, are going to be shocking. I would not be surprised to see market losses exceeding the 50% investors experienced in the last two bear markets.
2. Volatility will probably be higher, and market swings more dramatic than at any other time in history.
With technology, investors worldwide have instant access to market-moving news, which feeds the herd effect of investors moving in concert to take risk off or put risk on. As investors sell en masse in an attempt to take risk off and get liquid, they create liquidity traps that cause all asset classes to decline. We have seen this play out most recently over the last month as stocks, bonds, gold, and commodities collapsed in prices.
3. There will be an inflection point where virus cases peak and start to decline just as massive monetary policy and fiscal stimulus efforts kick in.
- The adage of “don’t fight the Fed” is likely to come quickly in focus because you won’t want to be fighting the Fed and the U.S. government combined.
- Markets may soar and even get close to former highs. This could be a very fast melt-up, but I foresee more of a bear market rally than the start of a new bull market.
- The damage caused to the economy should come back into focus with the likely economic struggles in 2021, causing growth, employment, and corporate results to disappoint.
- A second bear market leg down will be very painful for investors to take after the enormous losses many will incur during the next phase of crisis in the next few months.
- As the economy firms in late 2021 and 2022, we should build a solid foundation for the next bull market, which could provide extremely high returns for a few years as long as governments don’t make a strategy mistake and pull back on fiscal and monetary support.
4. Extremely low interest rates on government debt provide a rare opportunity for the Treasury to lock in low financing on the ballooning debt.
If they take this opportunity, they can insulate the economy and future generations from rising interest or cash flow costs to finance deficits. At the start of 2008, before the Financial Crisis, the national deficit stood at $9 trillion and had an average financing cost of approximately 3.5%. If we can finance our debt at 1.5% now by issuing 30, 50, and even 100-year Treasury bonds, we can finance our current deficit of $21 trillion at the same cash flow cost as the 2008 deficit. This is a big win considering the economy is more than twice the size today than it was in 2008. More than anything, we need economic recovery and growth, and I believe now is not the time to worry about deficits, especially when there’s potential to immunize the economy from the risk of rising interest rates.
I know that this a lot to take in, but the math of staying passively invested while taking large losses shows that it is a bad idea. We strongly suggest using an active management approach with someone like WBI, who has demonstrated proficiency at helping protect capital through multiple bear market cycles. You can set yourself up for success by limiting capital losses and then getting invested quickly off of market bottoms as we did in 2008 and 2009. Take advantage of last week’s bear market rally to help reduce future risk and loss until the risks from Coronavirus abate.
Most importantly, please keep yourself, your family, and others safe by adhering to the “shelter in place” guidelines suggested by federal, state and local governments.
The views presented are those of Don Schreiber, Jr., and should not be construed as investment advice.
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