MARCH 16, 2020 MARKET UPDATE
Economic stress and market volatility have only intensified since our last update on March 5th. It seems as though every day that goes by, we have more questions and fewer answers with regard to the current environment and how long this crisis is likely to continue. With all of the uncertainty, we wanted to take the opportunity to provide you with an update on what we feel are the most important economic and market related developments, and how we intend to guide your portfolio and planning through these unchartered waters.
What’s happened?
From March 5th, the date of our last update, US stocks (as measured by the S&P 500 index) are down an additional 19% through close of business yesterday. In total, from the market high on February 19th, the S&P 500 is down just shy of 30%. Bonds (as measured by the Bloomberg Barclays US Aggregate Index) have performed much better over that same period posting a positive return of 1.04%. With that said, bonds have come under some pressure recently as the broad index has fallen 2.65% since March 9th. The short-term pressure on bond prices has come as yields (bond interest rates) have bounced off of their lows on March 9th despite the extraordinary measures that the Federal Reserve has taken to add liquidity to the banking system and to keep interest rates low.
In our opinion, the most significant developments over the last two weeks with regard to the economy and financial markets has been the extraordinary actions announced by the Federal Reserve. The Fed announced last week that they would provide up to $1.5 trillion to the repo (repurchase obligations) market. The repo market is a very important source of short-term liquidity for large financial institutions. On Sunday, the Fed made another very significant move when they announced that they would drop the Fed Funds rate by another 100 basis points (1.0%) to target a range of 0.00% to 0.25%. In addition, they also announced asset purchases of up to $700 billion to support the longer term treasury and mortgage-backed securities markets. These moves are designed to keep interest rates low for mortgages and consumer/business loans. Lastly, just earlier today, they invoked another 2008 era measure by announcing a facility to purchase commercial paper. Commercial paper is a category of short-term loans (typically 30 – 270 days) that large companies issue as a way of financing near term operations. A lot of this probably sounds like gibberish, and we’d be lying if we said that we completely understand all of the inner-workings of the overnight funding markets. With that said, given the extraordinary actions that have been taken, we don’t think that you need to be sitting at a trade desk of a large financial institution to see that some of the critical components of the banking system are not operating normally. That realization is very concerning to us, but we are hopeful that the Fed and other central banks around the world learned some important lessons from the 2008 crisis and will not hesitate to take whatever action is necessary to stabilize the banking system.
Our View
Given the steep sell off in equity markets, it is logical question to ask, “is it time to buy?” As with any portfolio strategy or financial plan, there isn’t one right answer to that question for everyone. Time horizon and risk tolerance (both willingness and ABILITY to take risk) play an important role in answering that for each individual. With that said, as we look through the stocks that make up the S&P 500 index, we see that the majority of them are down YTD by 20%, 30%, 40% or more. Based on that, we do not think it is unreasonable to pick out some of the best run companies, with a wide economic moat and a healthy balance sheet, and believe that they will likely be worth more in 5 to 10 years than they are today. However, we do believe investors should exercise caution when “buying the dips” for two very important reasons. First, just because a stock is down 30% in a month does not necessarily mean that it is 30% undervalued. For that to be the case, it would imply that the stock was fairly valued prior to the major decline. We believe that many stocks were in fact over valued to begin with, especially when you look at an enterprise value metric that takes the amount of corporate debt into account in addition to simply stock price and earnings. The second reason for caution pertains to the uncertainty of the current environment and the extent of the economic damage that this crisis will ultimately cause. As we digest the daily news and review what’s going on within the financial markets, one of the most interesting developments has been the complete lack of negative revisions made to estimates for economic growth and corporate earnings. After yesterday’s market sell-off we’re beginning to see some analysts and market commentators change their tune, but up through last week the majority of “experts” who we’ve heard and read have been predicting a V-shaped recovery in the second half of the year. In fact, the median estimate for real GDP (economic) growth in the United States for 2020 is still at 1.8% positive growth and has not changed since December. Analysts estimates for what the basket of companies in the S&P 500 will earn in 2020 have only come down 4%, and still represent a positive growth rate of about 5% over what they earned in 2019. One contributing factor to what seems to be stubbornly optimistic earnings/economic forecasts is simply the fact that analysts really have no idea how to quantify the short- or medium-term effects of this environment. There is certainly a possibility in the short-run that some positive news regarding virus containment or additional monetary and fiscal policy actions could cause the market to jump higher. However, we believe that there is also still significant risk to the downside if it becomes apparent that the economic effects of the crisis will be longer lived resulting in a significant downward revision in corporate earnings.
The current market environment is very fluid. As we mentioned in our last update, we believe it is critical to have a well thought out strategy going into times of crisis so that we’re not making decisions on the fly as to how to plan for near term liquidity needs or how to invest longer term allocations. As of today, we remain cautious, but we also understand that the stock market is forward looking and that stock prices will rise well in advance of an “all clear” signal for corporate earnings and the economy. Regardless of what tomorrow holds, please rest assured that we remain vigilant in doing everything we can from a financial planning standpoint to help you through these difficult times.
As always, we appreciate the confidence that you have placed in us as your trusted advisor and we welcome your questions or comments at any time.
Important Disclaimer
JPS Financial, LLC is registered as an investment adviser with the Securities and Exchange Commission and only transacts business in states where it is properly notice filed or excluded or exempted from such filing requirements. Registration as an investment adviser does not constitute an endorsement of the firm by securities regulators nor does it indicate that the adviser has attained a particular level of skill or ability.
Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors on the date of publication and are subject to change. The information presented does not involve the rendering of personalized investment advice and should not be construed as an offer to buy or sell, or a solicitation of any offer to buy or sell the securities discussed. All investment strategies have the potential for profit or loss.
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