1st Quarter 2020 Key Takeaways
Crazy times, unprecedented times, and you are prepared:
You just witnessed the fastest 30% decline from a recent high on record for the S&P 500 – in only 30 days. We have experienced historic volatility. No one likes bear markets and red flashing across the screens, but we have prepared for this. No, we did not see a virus wreaking havoc on the health of society. No, we did not anticipate a deep recession brought about by draconian governmental measures that shut down our economic engine, but we have been preparing for this.
The core values outlined in my book “18 Common Sense Rules for Enjoying a Successful Retirement (2007)” call for eliminating all debt, diversification, emergency funds, living within your means, etc. We have been teaching that the bull market was running a bit long in the tooth and that we could experience a downturn in the future. Our last education seminar in January of this year had a slide titled “Something has to give,” showing where stock prices had far outpaced corporate profit growth. Low interest rates and tax cuts had “let the good times roll,” and we were loving it. The problem with predicting markets is that good times can continue far beyond what might seem logical from an examination of the data. To try and sidestep potential bad markets would mean giving up the great returns we had received in 2019. When all is said and done, you are better off capturing the good times in 2019 even if you take a temporary hit in 2020.
Year to date, larger-cap U.S. stocks have fallen 21%, having rebounded a bit from their historic drop. At one-point U.S. stocks were down 36% from the high to low. Smaller-cap U.S. stocks have done poorly, falling 32% YTD. Developed international stocks have fallen 25%, and emerging-market stocks have dropped 26%. Much of the differential between U.S. and foreign stock market returns has been due to the appreciation of the U.S. dollar, which has risen roughly 2% year to date.
In the fixed-income markets, core bonds have gained 3%, once again playing their key role as portfolio ballast against sharp, shorter-term stock market declines. Yields have been extremely volatile as well, shooting up on some days when stocks were also sharply selling off. At one point our US Treasury Inflation Protected Bonds were trading at a negative 5% for the year. Yikes, government bonds losing money! These certainly have been strange times. Returns for Government bonds have since stabilized
For our clients electing to hold private real estate, it currently feels like a portfolio godsend with price stability.
Turning to the credit markets, floating-rate loans and high-yield bonds have taken it on the chin. Both have dropped over 14%. Investment-grade corporate bonds have been far from immune, having lost over 5%.
The near-term economic damage from the United States’ and other countries’ response to the coronavirus outbreak now looks almost certain to be severe. GDP is expected to sharply contract, potentially by historic proportions, and unemployment is expected to rise to levels never seen before. The depth and duration of the recession (and the speed of the recovery) depend on the effectiveness of our medical and policy responses. A medical resolution is a “known unknown.” But the Federal Reserve and other major central banks seem to be all-in to support markets. At the same time, Congress and the Trump administration have undertaken massive fiscal stimulus, and more will follow as is deemed necessary.
1st Quarter 2020 Investment Letter
We are living through an extraordinary period in history that none of us will ever forget. The impact on our families, communities, and country has been profound. While several months ago we had reason for cautious optimism that the coronavirus might be largely contained to China, it is now obvious that is not the case. What is also obvious is that the data coming out of China sharply (and criminally in my opinion) under-reported the number of deaths from the virus, giving many of us a conclusion that the virus have a limited impact. The United States and world are now facing the dual threats of a health crisis and an economic crisis. Both need to be fought with monumental government policy responses and individual behavioral changes.
We’ve frequently said that recessions and bear markets are inevitable phases within recurring economic and financial market cycles. We’ve also said there is always the risk of an unexpected “external shock” to the markets and to the economy (e.g. a geopolitical conflict or natural disaster). Investors need to be prepared for both to happen, but their precise timing is consistently unpredictable. We’ve learned that it’s one thing to say it and another to live it.
But we will get through this crisis period. Things will improve and recover. Most importantly, we sincerely hope that you and your loved ones can remain healthy and manage well through this challenging period.
Update on the Macro Outlook
We entered the year with an outlook for a moderate rebound in the global economy (especially outside the United States) on the back of reduced U.S.-China trade tensions and extensive global central bank monetary accommodation. Our outlook now is that the U.S. economy is headed into recession in the 2nd quarter. It is likely to be a severe one, with a sharp contraction in GDP and an unprecedented rise in unemployment.
The near-term economic damage from the United States’ and other countries’ response to the virus now looks almost certain to be severe (barring some unexpected major medical breakthrough soon). The current Wall Street consensus 1st quarter and 2nd quarter GDP forecasts are for annualized declines in the range of 12% to 30%. One positive to investing is that investors typically look out 6-9 months and will place their bets accordingly.
The depth and duration of the recession – and the strength and timing of the ensuing recovery – depend on two key variables:
1) The effectiveness of our medical responses and social policy efforts in flattening the curve
2) The speed and effectiveness of our fiscal, monetary, and regulatory policy responses.
One lesson learned from the 2008 global financial crisis is that a policy response needs to be significant and executed quickly. Governments need to make a credible commitment to “do whatever it takes” to support the economy and prevent a negative spiral from taking hold. As of this writing, the Federal Reserve and other major central banks seem to have gone all-in to support the fluid functioning of credit, lending, and financial markets in their critical role as the “plumbing” of the real economy. Congressional Republicans, Democrats, and the Trump administration all seem to be in agreement that something massive needs to be done and done quickly. On March 27, Congress passed, and the president signed into law, a $2 trillion stimulus package.
Portfolio Positioning
Using our Medium Risk models as an example, we have let the cash accounts build from dividends. We have a sizable amount of bonds and liquid assets. The reason for these defensive measures is to provide you, our clients with any cash you might require during difficult times without having to liquidate stock positions. Some clients in our larger portfolios have elected to follow our lead and invest in private real estate, which is providing substantial stability during these turbulent times. When we feel the coast is clear (mostly indicated by less volatility), we will invest the excess cash and rebalance the portfolios. Remember that rebalancing is a simple concept of selling the investments that are high and buying investments that are low. In this case that will most likely mean selling off the bonds and buying stocks.
Closing Thoughts
During these historic times, it is paramount to stay disciplined and to recognize when emotion rears its head in investment decision-making. If we invest based on emotion, we are very likely to exit the market after it has already dropped meaningfully, which would mean locking in losses. By the time the discomfort and worry are gone, the market will already be much higher. That is not a recipe for long-term investment success.
More money is lost from irrational investors looking for short-term profits or being scared out during difficult times than is ever lost in the stock market by long-term investors. The unfortunate fact is that all of us – including myself – have our mental limits. That’s why having someone else to lean on and work with during times like this is so important.
Global markets have endured severe challenges and economic downturns in the past and have always weathered the storm. Attempting to time the market’s tops and bottoms is a fool’s errand. However, incrementally adjusting portfolio allocations in response to changes in asset class valuations, expected returns, and risks can be highly rewarding to long-term investors.
The ideal time to be adding to stocks and other long-term growth assets is when prices are low and when markets are gripped by fear and uncertainty. It may seem like the market could just keep dropping with no bottom in sight. But that is exactly where research, analysis, patience, experience, and having a disciplined investment process come most into play.
The precipitating event for the recent volatility – a global pandemic and an extreme societal response – is something that none of us have experienced before. One in two Americans now live under lockdown. Our medical infrastructure could become overwhelmed. And we have just entered a global recession.
The U.S. is about to test the theory that deficits don’t matter. Our government owns the printing press to the world and has an unlimited supply of money. This concept seems illogical to most of us. However, as long as the world operates on the U.S. dollar, this will be true. We can simply print our way out of this mess. Thankfully in this current time in our history the whole world is running to the U.S. dollar for safety; and that my friend is our salvation in Phase I of this crisis.
There are potential ramifications of just printing money. Inflation can rage out of control. I must admit that my predictions of high inflation were wrong after our governmental response in 2008. This time we are attempting to solve the problem with more aggressiveness. Will the result continue to be low inflation and the avoidance of depression? Or will the economy gulp down another sugar pill and go on a tantrum like a two-year-old child? Be assured that we are intensely looking for rational solutions to protect your nest egg during Phase 2 of this crisis. Stay tuned.
The future is uncertain but let me end this letter the way I started. You are prepared for this difficulty. We knew it would come. We didn’t know when and we didn’t know what would trigger the event, but you are prepared, and you will weather the storm.
We will continue to walk side by side with you during this storm. Many of you will want to revisit your financial plans. We have had the opportunity to rerun a few plans and are pleased that they are still on track for success even after the market pullbacks. If your plan happens to be one that is not, we can offer constructive ideas on getting you back on track.
I just wish investing was easier. I wish my crystal ball would allow me to be fully invested in 2019 and then sidestep the difficulties of 2020. When God was passing out talents, this isn’t one that was granted to me. So, the best we could do is prepare everyone to participate well. In my heart I believe we have done just that.
Finally, if you know of any friends, coworkers or acquaintances that could benefit from our services and advice, please do us the honor of helping them make a connection with us.
As always, we appreciate your confidence and trust in us.
Please stay safe, stay healthy, and stay positive.
Ron Dickinson, CPA, CFP®, MPA-Tax
[Financial Planning and Investment Management Services offered through Dickinson Investment Advisors, Registered Investment Advisor. Statistics and market information provided by Litman Gregory Advisor Intelligence.]
