I made a decision in December to switch from monthly updates to quarterly ones and of course it’s been one of the most active quarters I’ve ever experienced. I truly hope everyone is safe, healthy and most importantly finding productive ways to spend the time in quarantine.

As I write this update on Saturday from my house in Austin TX, the virus continues to ravage our communities and the global economy. The Fed has embarked on an unlimited monetary stimulus while the government has passed a $2 Trillion stimulus package with likely more to come. There’s a lot of pain out there in the world and while I do get a sense of camaraderie similar to the impact 9/11 had on this country, I do wish it didn’t take a crisis to bring us together.

Here are some highlights from the quarter which in no way encompasses everything that’s happened. There’s just too much news and the situation is incredibly fluid. This will be a chart heavy update as well.

  • The equity market dropped the furthest and fastest ever. At one point, it was down 30% before rebounding. My personal perspective is we have not yet seen the lows in the equity markets. The market is having to digest the reality that we may have 200,000 deaths alone from the virus. Furthermore, we saw “stress” in almost every asset class in ways that didn’t make a lot of rational sense. The only explanation that I could come up with is a rush for liquidity that affected every asset class. Leave it to a black swan event to show us that you can’t hide in any asset class.
  • Over the last 2 weeks, unemployment claims spiked 6.65 million which is certainly the largest spike we’ve had in history.
  • Payrolls fell 701,000 from the prior month which was the first decline in monthly payrolls since 2010. The jobless rate also jumped to 4.4% and is likely to continue marching higher in the coming months. I’ve seen projections as high as 30% and 30 million unemployed in the coming months.
  • While no one is arguing that we’re in a recession, the depth and rebound are subject to wide projections. So far, most economists believe we’ll see a big recovery in Q3 and Q4 and into 2021. Morgan Stanley is now predicting between a 38% and 45% drop in GDP for the second quarter, after a small drop in the first quarter. Even with the rebound in their moderate case, they still project a 4%-plus year-over-year recession in 2020. They acknowledge it could be much worse.
  • U.S. coronavirus deaths could reach as high as 200,000, National Institute of Allergy and Infectious Diseases Director Anthony Fauci said, a stark warning as debate rages about how soon to restart parts of the U.S. economy that have been on shutdown.
  • According to a US report, China has concealed the extent of the coronavirus outbreak in its country, under-reporting both total cases and deaths its suffered from the disease. I’ve seen reports that show the death toll in Wuhan was closer to 40,000, not several thousand that were included in the official report. Not a surprise that China has possibly fabricated data and that it’s denying it.
  • We passed a $2 Trillion stimulus plan which has a lot of moving parts that I’m not going to break down in a lot of detail. If you’re a business owner, looking into the Paycheck Protection Program is a must. The individual stimulus checks being sent out are not going to go very far and is disappointing imo as compared to other countries.
  • The Federal Reserve has launched unlimited QE and restarted a lot of GFC era programs. It’s an alphabet soup of programs
    • PMCCF and SMCCF – Primary and Secondary Market Corporate Credit Facilities to buy corporate bonds of 1-5 year maturities (new issue and traded market)
      • The Treasury Department will put $400 billion into the Exchange Stabilization Fund, but the Fed can lend 10x that amount – $4 trillion – when fully levered. A 10-for-1 multiplier on that capital.
    • TALF – Term Asset Backed Securities Loan Facility – supporting the issuance of securities backed by SBA loans, auto loans, student loans, and consumer credit
    • MMLF – Money Market Liquidity Facility – allowing the Fed to buy a wider range of instruments that help feed liquidity and efficiency to money market funds
    • CPFF – Commercial Paper Funding Facility – allowing the Fed to provide liquidity in the vital commercial paper market, and even use the market to buy short term municipal paper
    • MSBLP – Main Street Business Lending Program – allowing the Fed to support lending to small and medium sized businesses (basically by securitizing SBA loans)
    • PDCF – primary dealer credit facility
  • Every sports league canceled games from NBA to major league. It’s likely that we won’t see a professional sports game for several more months.

My 2 Cents:

Let me start off my saying the obvious; this is unprecedented in modern times. We have literally no clue when this will be over and the ultimate damage to human life and our finances. Any attempt to forecast how far the market will decline or how bad GDP growth (or any other financial data point) will be dart boarding. We will all likely know someone directly or indirectly who will die from this and most of us already do.

I’ve been on more conference calls and read more analyst reports over the past month than in any other time period. The collective consensus appears that employment, GDP and earnings are going to rebound very quickly so the risk to the market expectations is that this happens slower than expected.  And I’m starting to believe that we won’t have an immediate bounce back in employment and that it will take time to recover from this impact.  A lot of businesses are going to fail and people will be unemployed for longer than we’d like. If we see 20 million unemployed/an unemployment rate above 10%, it will take years to fully rebound.

Forecasting firm Oxford Economics projects that by May, the U.S. will have lost 27.9 million jobs and have a 16% unemployment rate, erasing all the jobs gained since 2010 during the record-setting 113-month stretch, which ended in March. That job loss would be more than double the 8.7 million positions cut from payrolls during the 2007-09 recession and its aftermath. And those jobs were lost over 25 months. These jobs are not going to come back overnight.

I do believe that long term we will be OK and return to normal. But it will take time. As investors we have to take the long view here imho. If we see a stock market down 35-55%, it’s going to be very difficult not to aggressively purchase stocks (assuming we can foresee light at the end of the tunnel). While a lot of companies will go bankrupt, more won’t and the ones that do survive are going to emerge stronger than before for having gone through this period. I don’t give broad advice here and if you’re a client, you already know my perspective (with more details to come soon).

A New Paradigm?

We live in a world where our financial system is highly fragile due to the amount of debt and leverage within our system.  And while COVID-19 is devastating exogenous event, it wouldn’t have taken much to cause problems in global markets.  The more stretched our system, the more susceptible it is to these types of shocks.  

With unlimited monetary stimulus underway and a $2 trillion fiscal stimulus, what happens if we see a resurgence in virus cases in the fall/winter like we did with the Spanish Flu of 1918?  This would likely cause us to shelter in place again and require further monetary and fiscal interventions.  In this scenario, we will likely see further volatility and liquidity “issues” like we’ve witnessed recently.  While a lot of people will have immunity, a lot still haven’t been exposed to the virus and are susceptible (with testing we’d have better data to help us make decisions). A vaccine is what we and market needs to see the light at the end of the tunnel.

Regardless if we don’t see a surge in cases (or a widespread vaccine is available before the fall), our system is even more vulnerable than before with a Fed balance sheet likely around $10 trillion. The world is hooked on fiscal and monetary stimulus like never before. Any blip in the road will likely be met with more stimulus and more debt that cannot be repaid. I just don’t see how we’re going to de-lever without causing additional problems.

Charts, Commentary & Perspectives

(In no particular order)

Before the coronavirus outbreak, the S&P was trading at sky high forward PE ratios. It’s should not be a surprise why markets have fallen so fast as participants reprice risk and earnings.
China’s consumption in various industries has grown incredibly since 2002 when SAARS outbreak.
Fallen angels occur when a firm goes from investment grade credit rating to junk status. We will undoubtedly see a dramatic spike as balance sheets deteriorate from the lack of sales combined with larger debt loads from the stimulus package. We had a record amount of BBB debt one notch away from junk which has been widely reported on.
This only shows part of March but gives you an idea of how volatile this past month has been. To say it’s been a wild ride is a massive understatement.
The drop was fast, furious and gut wrenching for yours truly (and likely others too).
The average decline in recessions since 1948 has been 26% but Goldman expects this one to be 41% from the peak. Take all forecasts like this as what they truly are; guesses.
If past recessions are a guide to this one, we may not have seen the bottom yet in the equity markets. Patience is key. Most metro areas are in lockdown and will likely still be for at least another month.
We’ve had a big bounce off the lows but if we look at past declines from the GFC, this price action is to be expected and doesn’t mean we’re anywhere close to out of the woods yet.
Another chart showing that bear markets rarely bottom with one big fall. According to Gavekal research, in all but 1 in 15 bear markets since 1950, the market retests its lows at least once.
Corporations have been the largest of equities since the GFC if this chart is accurate. If they are unable to purchase shares, the largest buyer of the market is on the sidelines.
This stimulus package is so far over double what we saw in 2009. And there’s expectation that there will be another package since this one didn’t go far enough.
We really screwed up testing here in the US, big time. The countries who’ve been able to flatten the curve have been testing at a high rate. I’ve known people who’ve come back from international flights without any guidance on self quarantine. No temperature tests. Nothing.
Another chart showing how delinquent we were with testing.
And it’s because of the way we’ve handled this crisis that we are so far the worst at flattening the curve. Many will die due to our inactions and many will look to our leaders for where to place blame.
Q2 GDP is looking to be an absolute bloodbath. Forecasting right now is futile and you can see that with how dramatic the differences are. Goldman expects -34% drop while UBS is only forecasting -9.5% (as of the date of this graph). That’s a 24.5% difference in forecasts.
For a brief period, the 1-3 month T-Bills were in negative yield territory as flight to safety spiked during the volatile days of mid March.
Banks appear to be better positioned today than before the GFC when looking at tier 1 capital ratios. However, with potentially 20-30% of small businesses going bankrupt (plus some larger ones) I believe it’s too early to tell how this will play out for them.
This is a great infographic for where the $2 trillion from the stimulus act is going.

I hope you enjoyed this months financial markets update.  If you have any questions please contact us directly.  If you’re interested in a topic that you’d like us to address, please email us so we can include them in future updates.

If you’re interested in starting a dialogue and learning how we can help, please contact us.

Best Regards,

Jared Toren
CEO & Founder

Sources: Edges & Odds, WSJ Daily Shot, 361 CapitalSteve Blumenthal’s On My Radar

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