Articles and Resources from the FourThought Team

< back March 17, by FourThought Private Wealth

Coronavirus: Now It’s Personal

 

Two weeks ago we shared with you the concept of street signs to assist us in forecasting the impact of the coronavirus on the economy and markets.  We noted that it is impossible to predict the destination to which we are traveling, but if we pay attention to the street signs we can narrow the possibilities and make adjustments during the journey.

Let’s first state the obvious: Everyone has experienced declines in the value of their portfolios. Americans are doing what many thought they would not and changing their ways.  Social distancing and germ awareness are not only recognized but considered essential.  The hope is that by slowing the spread of the virus, we will allow our health system to prepare and provide time for therapeutic advancements to develop.

The purpose of this edition of “FourSight” is NOT to provide you with coronavirus news (you can get that through other sources) but rather to share with you our thoughts on the market and what we are doing in the portfolios. 

We are watching several fronts:

  • Our financial system: Is it at risk and what is being done about it?
  • Our clients: What will be the virus’s impact on your long-term plan?
  • Recovery: What can we do to mitigate the damage and take advantage of the inevitable recovery?
The Financial System

During the global financial crisis of 2008 the “plumbing” of the system failed.  Banks became insolvent, liquidity in the system dried up and the global economy suffered as a result.  Federal Reserve Chairman Ben Bernake, Treasury Secretary Paulson and then Timothy Geitner had to lobby Congress and the American people to institute plans known as quantitative easing, Fed-led asset purchasing agreements, and plans with names like TARP, the Public Private Investment Program and the Capital Purchase program.  They had to fight for congressional approval. Some countries tried a different approach called “austerity.”

Since then, many have grown to believe that the Fed and other central banks can and should step in to ensure that all facets of our complex financial systems are operational.  This week the Fed did just that. Steps they took included:

  • Cut interest rates
  • Agreed to buy $500 billion of U.S. treasuries and $200 billion of asset-backed securities
  • Cut the direct loan rate to banks and loosened the regulatory guardrails and buffers limiting loans

(Source: Wall Street Journal)

The Fed doesn’t need to lobby Congress to take these steps.  It has the authority to maintain a functioning financial system. Whew. In our opinion, it appears as if we’ve learned a good lesson since the troubles of 2008.  Currency spreads, loan rates on carry trades and other fancy sounding things have been stressed, and the Fed seems to have eased the stress.

The Impact on Your Plan

We continue to believe the virus will not have a substantial impact on diversified, long-term plans.  In many of our portfolios, we took steps to prepare for these types of unexpected “floods” by building in five years’ worth of liquidity, set aside in the form of future dividends and interest as well as short-term bonds and CDs. The goal is to prevent the need to sell.

As an analogy, pretend that you own a successful restaurant in Venice.  Last year you made $150,000 in profits.  Assume that if you sell your business, you could get five times profits or $750,000.  It just so happens that you were in negotiations to sell your business when the coronavirus struck.  You anticipate that because of business disruptions and the extra costs of caring for employees this year you will have no profits.  What is the value of the business?  The answer is probably still around $750,000.

The reality is that disruptions are part of business life.  In downtown Venice, we have dealt with construction, red tide and the threat of hurricanes.  The coronavirus could be prolonged but in the end, from a business perspective, it is another disruption and is already priced into the valuations.

It is important to remember that you own a portfolio including stocks, and stocks represent businesses.  The degree to which these businesses are or may be impacted by the coronavirus varies.  Take one of our largest holdings, Microsoft.  They have a fee- based model in which millions of users pay them regularly for their office suite of products.  We do not believe their revenue or dividends will be materially impacted.

The pharmaceutical industry may be well positioned. And, some companies in our portfolios—like  Walmart, 3M, Walgreens, CVS, Target and Amazon—are actually having to hire to keep up with the demand for their products.

As of today, March 17, the market is down 30 percent from its high.  We believe that we are in the bottoming process.  There is a term called “capitulation.”  From a market perspective, capitulation occurs when investors are personally frightened and can’t tolerate the constant market declines.  We are experiencing an undesirable situation in which not only are inexperienced investors selling without understanding the value of their assets, but “quant” managers are selling as well. They use algorithms to manage large sums of money and automatically sell when the market deteriorates.

What are we doing? Sticking to our recommendation: say bye-bye to the virus and buy buy buy.

Our Positions and Portfolio Moves

We fear the impact of the virus on the emerging markets.  Countries with weak health care systems could be severely damaged.  Therefore, we are eliminating our exposure as much as possible to these economies. Our reasoning is that many of these funds (especially the debt funds) are down about the same as U.S. markets, but have substantially more risk.  We believe and hope that the U.S. and China will lead the way out, and want to focus our capital there.

Secondly, we are reducing our exposure to Europe.  We feel that will have a less coordinated policy response and potentially less effective virus response, or at least it seems.  However, there are still terrific global brands that are based in Europe that we hope to scoop up when the price is right.

We are bullish on U.S. and Asian equity markets because we believe valuations and business potential are attractive.

From a sector perspective, we continue to underweight banks and will be reducing our exposure to the insurance and financial services industries. We favor consumer staples over consumer discretionary companies (think Clorox vs. Starbucks) and technology.  Interestingly, the tech sector was feared to be overvalued, but as a sector it has not underperformed the market.

In summary, the Fed is taking steps to shore up our financial system, Americans are taking the coronavirus seriously, and the markets are being driven by program trading and panicked investors.

People want to know what is going to happen.  As we have stated often, we are not gods but we will make this prediction: the markets will continue to be very unpredictable.  Just remember that your portfolio contains solid businesses, many of which have survived other threats.  We all knew that there would be “floods,” but we have arks to get us through.

 

A note from the FourThought team: If you feel your risk tolerance has changed and want that reflected in your investment strategy, or you want to move to a more conservative strategy, please call us to discuss.