April 2020 | Victoria Bogner, CFP®, CFA, AIF®
As we all know, the coronavirus pandemic has shuttered the world, severely affecting the global economy. As of yet, shutdowns remain in effect with no real answer as to when we can fully open back up. And even if your state gave the all clear tomorrow, would you feel comfortable going to a packed movie theater, sports stadium, or Chinese buffet?
I think that the pandemic is going to change consumer behavior for a while, not just because of the fear of contracting the virus, but because of much lower income. We’ve now seen unemployment numbers spike at a rate that has shattered prior records. Nearly 22 million Americans filed for unemployment benefits during the three weeks ending April 11th. While I don’t know anyone who personally has COVID-19, I have several friends who have been laid off for the first time in their lives.
Meanwhile, corporate earnings estimates are out the window. Who can possibly guess how much a company will earn in the next quarter or two? Many companies have withdrawn guidance completely. We’re in uncharted waters. But that hasn’t stopped the S&P 500 from rallying over the past three weeks and regaining over 50% of what it lost in February and March. Below is a year-todate graph:
With where the S&P 500’s price is now, forward P/Es (a broad measure of how expensive stocks are) are back to pre-virus levels of 18.9 and above the 20-year average. Stocks are expensive at these prices, especially with the “E” part of the equation (aka, earnings) set to go much lower.
While we don’t have the official numbers yet, it’s pretty much a given that we’re in a recession. There’s a lot of disagreement about how deep and long it will be. Forecasts from economists range anywhere from -9% to -50% (on a quarter-overquarter annualized basis). Economic growth in the second quarter is expected to fall to the largest contraction in real GDP since WWII.
The prospective shape of the post-virus recovery—whether it looks like a V, U, W, Y, L or any other letter (yes those are real letter shapes that are being discussed) —has also been heavily debated among economists and investors. The simple fact is, we can’t know for sure. A lot is going to depend on the consumer and how safe (and financially equipped) they are to get out there and spend again.
What about stimulus measures? Germany’s stimulus is now more than 20% of its GDP and the totals in Spain, France and the U.K. exceed 15% of their respective GDPs. This is about five times the amount provided during the global financial crisis of 2008-09. The US’s stimulus package is roughly 10% of GDP thus far but growing rapidly. In six weeks, the Federal Reserve has lowered the federal funds rate to a range of 0.0-0.25%, increased its bond holdings by more than $1.6 trillion, eased bank regulations to encourage more lending, opened up lending US dollars to foreign central banks, and set up facilities to increase the flow of credit to households and businesses. Yet with all of that, credit spreads remain high (although they’ve come down off the peak a bit).
And as I’ve said before, high credit spreads mean a lack of confidence in the bond market. And if there isn’t confidence in the bond market, it’s even more difficult to have confidence in the stock market. And we’re now seeing some of the consequences of an extended lock down with oil prices collapsing this month.
For the first time ever, an oil futures contract went negative on April 20 th . In theory, that means producers were paying people to take oil off of their hands! There simply isn’t anywhere else to store the stuff, and producers are shutting down across the country. That is resulting in even more layoffs and a potential wave of bankruptcies if oil prices don’t rebound in the next month or two.
The next sector I’m watching very closely is housing. While it sounds great to allow borrowers to skip their mortgage payments for up to 12 months, it creates some problems in the background. Mortgages are packaged and sold by servicers (many being banks) to bondholders, insurance companies, and investment companies. The servicers have an obligation to pay the principal and interest of those mortgages even if the borrower doesn’t. Normally that’s not a problem, especially if you hold high quality mortgages. But what happens if even those high-quality borrowers are given the option to stop paying their mortgage for a year? It’s estimated that up to 25% of borrowers may take advantage of this forbearance, but servicers don’t have the resources to keep making payments to bondholders when they aren’t receiving payments from the borrowers. This has the potential to be a big problem, and so far, neither Congress nor the Federal Reserve has stepped in with a lending facility to help these servicers continue to make good on their obligations. If left unchecked and servicers begin to go bankrupt, that could have a severe ripple effect throughout the banking system and credit markets. My hope is that the Feds have seen this movie before thanks to 2008 and will go to great lengths to prevent this from happening, but they have a lot of fires to put out at the moment.
So what do we do now? As our clients know, we’ve become more defensively positioned during the market rally of the last three weeks to protect against the unknown risks. We’ve purchased high quality bond funds and buffer ETFs as part of that plan. If you aren’t a client of ours, then the best thing to do is to make sure you have a widely diversified portfolio that matches your risk tolerance. It’s also a good idea to rebalance monthly at this point to bring it back in line with original allocations. But overall, investors should be prepared for a bumpy ride— with the economic outlook so uncertain, volatility is likely here to stay for a while.
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