The COVID-19 outbreak has led to unprecedented volatility and tremendous declines in wealth, but we have faith that once the pandemic is defeated, the wild swings in the financial markets will abate and prosperity will return. But what cannot be so easily recovered is the loss of a job, the loss of a business, or, worst of all, the loss of a loved one. While it is our duty to provide timely market insights, please know that now, more than ever, the health and safety of you and your families is at the forefront of our minds.
The Hubble Space Telescope celebrates its 30th anniversary in April. As the first major optical telescope soaring through space, its vitality in astronomical discoveries earned it the nickname “window on the universe.” Since its launch in 1990, its discoveries have redefined our knowledge of the universe – from its esti- mated age (~13.7 billion years old) to the two moons circling Pluto. Its ability to capture clear, concise photographs is due to its location beyond Earth’s atmosphere, where it is unencumbered by clouds and turbulence. The traveling telescope is an excellent metaphor for our investment strategy journey, as we seek to pro- vide clear, concise views in a world of incessant change and increasing complexities. Not getting fixated on the daily headlines and approaching investments with a long-term view in mind can help avoid panic driven portfolio decisions.
The emergence of the coronavirus as a global pandemic was a ‘Black Swan’ event outside anyone’s scope. Its discovery clouded the near-term economic outlook and created unparalleled market turbulence. As this unprecedented event unfolds, it is our responsi- bility to bring uncertainties into focus and provide pragmatic, insightful views to assist you in navigating your portfolio during this historically challenging time.
When it comes to the economy – Houston, we have a temporary problem. The COVID-19 outbreak and its negative economic impact are difficult to discern given the inability to determine the number of people infected, the transmission rate, and the longevity of the spread. But one thing remains clear – consumer spending is collapsing at a record pace due to the necessity for social distancing– the avoidance of restaurants, movie theaters, tourism and spec- tator events. Already, more than 46,000 US retail stores have shut their doors, major league sports have suspended their seasons, and over 515 million students have been impacted by school clos- ings worldwide. With consumer spending, which represents 70% of the US economy, contracting rapidly and likely remaining con- strained for the next few months, a temporary virus-induced recession seems unavoidable. With spending in an interim black hole, our Healthcare Policy Analyst, Chris Meekins, assigns a 40% and 80% probability to the US starting to “turn the corner,” or real- izing the true scope of the health crisis and resuming our normal activities, by Memorial Day and the Fourth of July, respectively. If this proves prescient, the US economy would likely experience a robust rebound during the second half of the year, especially if pol- icymakers continue to exhibit a “by any means necessary” approach to defeat this virus.
Mitigating this downside risk to the economy is the beaming up of policymaker response. The Federal Reserve (Fed) has been and will remain proactive. Even after implementing two inter-meeting interest rate cuts – action only taken once in a blue moon – to reduce interest rates to zero and once again employing massive tril- lion dollar facilities, the Fed is still exploring ways to make sure the gravity of the situation does not cause the lending markets to function inefficiently. But the Fed is not alone, evidenced by the all hands on deck effort by central banks around the world similarly easing in a synchronized fashion. Over the last six months, almost 80% of central banks have eased policy rates – the highest level since the Great Recession. In fact, the average policy rate amongst the four largest central banks (the Fed, the European Central Bank, the Bank of England, and the Bank of Japan) has fallen into nega- tive territory and set a new historic low. While these measures cannot cure the health crisis, they should help boost confidence and support a rebound in growth over the medium to longer term.
Congress and the Trump administration have executed several phases of their fiscal stimulus mission. While the health and wel- fare of citizens is at the forefront of any president’s mind, President Trump has a heightened incentive to keep the economy shining bright to maximize his chances of a successful re-election cam- paign. Combined, the record-setting stimulus packages will put more than $2 trillion into the hands of consumers, small businesses and distressed industries (e.g., airlines) in hopes of easing the economic impact of the virus. If the economy continues to struggle, we do not rule out additional phases of fiscal stimulus.
With fear driving demand for US Treasuries, yields moving higher will continue to exhibit a failure to launch scenario. Uncertainty surrounding the duration and magnitude of the virus fueled a flight to safety mission that pushed the entire yield curve below 1% for the first time ever. If volatility subsides and the economy not only stabilizes but resumes its upward trajectory in the second half of the year, we’d expect the 10-year Treasury yield to remain around the 1.00% level come year end. Given the substantial energy sector and brick and mortar retailer exposure of high-yield bonds, we maintain our preference for investment-grade debt.
After the best year for equities since 2013, the 33% plus corona- virus-induced decline has brought investors back down to earth by ending prolonged depressed levels of volatility, heightened levels of complacency, and the second longest bull market in US history. Due to direct and indirect negative impacts from the coro- navirus, Michael Gibbs, Managing Director of Equity Portfolio & Technical Strategy, lowered our 2020 earnings estimate to $155 with reductions weighted to first half 2020 results. Based on our expectation of a rebound in the latter half of the year, our 19.5x trailing multiple is unchanged, resulting in a revised 2020 S&P 500 price target of 3,023 (from 3,350). Once fears subside and the ben- efits of global monetary easing are felt, attractive valuations should entice investors back to the equity markets. Therefore, we remain long-term constructive on global equities, specifically US equities, and prefer cyclically-oriented sectors over defensives. The Informa- tion Technology sector should not be a falling star, as its secular growth story remains positive with the anticipated rollout of 5(G) later this year.
Although a long-term positive for the global economy, oil prices have fallen to levels not seen since many moons ago. The emer- gence of the oil price war between Saudi Arabia and Russia, compounding the dramatic fall-off in global demand (estimated to be worse than the 2008 and 2009 declines combined) has resulted in prices at which the global oil industry cannot sustainably func- tion. For this reason, the price war is bound to end soon. Further support for oil is embedded in our expectation that aggressive monetary policy and a burgeoning budget deficit (~$3 trillion) will cause the dollar to modestly weaken throughout the year. Oil will likely continue to test the $20/bbl level this quarter, while lock- downs and demand disruptions are the most severe, before rebounding towards $45/bbl by year-end.
It doesn’t take a rocket scientist to know volatility will be present in both the near and intermediate term. Selectivity remains of the utmost importance and just as the take-off and landing of the rocket are the most critical steps of a flight mis- sion, buying and selling decisions are critical to the success of a portfolio. Exercise patience rather than panic, and rely upon your financial advisor and asset allocation in order to achieve your long-term investment goals.
Please be safe and stay healthy!
Lawrence V. Adam, III, CFA, CIMA®, CFP®
Chief Investment Officer, Private Client Group