First Quarter 2020 Market View

During these challenging times, we want to stay fully connected with you. With this in mind, we’ve collected your most frequently asked questions about coronavirus, the economy, and the markets during the past quarter, and we’ll use this time to answer them together.

We’ve broken this Q&A session (which was recorded on Wednesday, April 8), into the following segments, for easier search and viewing:

• Intro & The Virus – events and trends around the epidemic itself.
• The Government/Fed/Macro Response and the Economy – events, trends, timing, risks, and opportunities.
• The Markets – events, trends, timing, risks, and opportunities.
• Fort Pitt’s Strategies and Tactics
• Miscellaneous – questions not otherwise categorized.

Market analysis provided by:
Dan Eye, CFA®, Head of Asset Allocation and Equity Research
Charlie Smith, Chief Investment Officer

These videos are moderated by Miranda Metz, Marketing Manager. You can scroll down to read a rough transcript of our conversation.

COVID-19 Virus– Events and Trends Around the Epidemic Itself

Are there any new developments that have you feeling more encouraged or more concerned?

• Very encouraged by the push from the global pharma industry, both in terms of advancements in testing capabilities and the efforts to find therapies and at some point, a successful vaccine.
• A lot that we could cover here, but to keep it short – we wouldn’t want to bet against the talent and resources that are working on finding solutions.
• Also encouraged by the drop off in new daily cases and new daily deaths in some of the hardest hit areas of Europe -such as Italy and Spain.
• We have seen new daily cases on a worldwide basis start to look like something that resembles a crest over the past few days as well.
• We are seeing a similar near-te­rm development in the U.S. And equity markets have certainly keyed in on these developments.
• So, I think these data points give us an indication that social distancing efforts are having the intended outcomes.

Everyone talks about China and S. Korea as being successful in their efforts to slow the spread of the virus, but we aren’t going to do those things in the U.S. So how can we model our return to normalcy after those countries?

• Efforts in January by the Chinese central government to halt the spread of coronavirus in the city of Wuhan (and Hubei province in general) could be described as draconian, but the nearly complete commercial shutdown of 42 of 50 U.S. states certainly comes close! Importantly, these measures are beginning to show results, with the national growth rate in U.S. cases slowing materially over the past 10 days.
• We’re definitely making good progress, so perhaps we CAN model our return to normalcy after these other successful nations. In that vein, we expect the administration to release an initial blueprint for the process of reopening our economy within the next 10 to 15 days.

When/how do you think the economy will be reopened?

• The “when” is harder than the “how”.  We’re reasonably certain of the conditions that must be in place before the process can start. First, a state or region cannot reopen until it is past the “peak” of the initial wave of infection.
• Second, health systems in each region must have the resources to deal with any second wave of disease.
• Third, sufficient testing capacity must be available to identify both those still infected and those with prior infection. If these conditions are met, people who have recovered from the virus, have immunity, are under 65 and have no other medical conditions could start the process. Basically, those presenting the lowest risks to both themselves and others will be allowed back first. Depending upon the rate at which the initial wave crosses the U.S., this process could begin as soon as early May.

The Government

The recently enacted Federal stimulus package and other moves by the Federal Reserve are significant.  How do they compare to the government’s response to the 2008/2009 crisis and do you think they will be effective?

• The fiscal stimulus and monetary responses are both massive.
• Biggest fiscal stimulus package in our nation’s history at almost $2.3 trillion, equates to more than 10% of GDP. Dwarfs the fiscal response in 08/09 which was around the $800 billion mark.
• And the Federal Reserve has cut interest rates to zero, announced an unlimited QE program and reopened their emergency programs created during the financial crisis to boost liquidity and support financial markets.
• The combination of the fiscal and monetary response equates to close to 30% of U.S. GDP
• And it’s not just the U.S., every other major economy is following in our footsteps with similar programs and the same goal
• We’ve already seen the Fed’s actions relieve significant stress in fixed income markets. We know another goal of QE is to support prices in equity markets as well.
• We aren’t naive, and don’t anticipate stimulus efforts will “spur demand”. The goal instead is to bridge the gap until the economy reopens.

Is the stimulus cure worse than the market-decline disease – what will the long-term impact be from this magnitude of stimulus and how long will it take us to climb out from that hole?

The rapidity and size of the Fed’s response certainly got the market’s attention. Fed governor Neel Kashkari appeared on 60 Minutes the evening of March 22nd. His statement that the Fed would do whatever it takes to stabilize the markets and the economy basically put a floor under the entire financial system. The S&P 500 has rallied 19% since the following day. That said, we don’t know if the fallout from unlimited money creation (at least for a short period) will result in much higher inflation, weak growth and grinding deflation as we’ve seen over the past decade, or some combination of the two.

Do you have any projection as to when the economy, GDP, employment etc. may start to return to normal? 

As for timing, if we had to guess, we would say that a rapid recovery could begin as early as the middle of the third quarter. Remember, this downturn was to a great degree a “cessation” rather than a classic “recession” – the equivalent of a medically induced coma. Once businesses everywhere begin to comprehend and implement new ways of doing business necessary in a post-COVID-19 world, the recovery could become surprisingly robust. The prospect of a protective vaccine arriving in the early part of 2021 could also boost confidence immensely.

Will this change the economic and market models?

• Charlie and I as well as the rest of the investment team have had good dialogue and discussions about how the environment will change, both economically and in terms of financial markets.
• Most of our discussions so far have centered on supply chains – are we going to see a push to relocate supply chains back to the U.S? Is “globalization” coming more and more into question? How do massive budget deficits and the prospect of “helicopter money” impact interest rates and our economic growth potential?
• What does the workplace look like after we have all spent weeks or months working remotely? How does this change impact real estate markets/values?
• We’re thinking a lot about “second order” effects of the pandemic and the changes it has forced on our collective behavior. Which changes are permanent? Which are not?
• In areas where we believe these changes are indeed long-term and will have lasting impacts – either positive or negative, we will make the necessary adjustments to client portfolios.

The Markets – Events, Trends, Timing, Risks, Opportunities

How does the current steep decline from equity market highs in February compare to other equity market declines in history?

• Not the steepest decline in history but it was a record setter in a number of ways
• Quickest decline into bear market in history with the S&P falling roughly 34% from February 19^th through March 23^rd.
• Also, the worst first quarter ever for the S&P 500 Index.

Are there parallels to other downturns like 2008-2009? Is this going to be as bad as that? 

• One of the parallels or similarities from my seat was how the fixed income markets, specifically the credit markets behaved, at least initially.
• We saw IG corporate bond markets down almost 22% from peak-to-trough over a 2-week period, high quality municipal bond index down 13% over the same time period.
• Some of that was investors reassessing the credit environment given expectations for near-term economic stress and some of it was just the “sell everything” mentality and liquidity grab
• As I mentioned, earlier the fixed income/credit environment has improved to a large degree since mid-March after the Fed stepped in decisively, but that period did remind me of the FC environment.
• But some important differences as well. Consumers are not as levered as they were back in 2007, going into the financial crisis, and they have dramatically repaired their balance sheets since the GFC.
• And really the same thing can be said of the banks. They aren’t levered 30:1 like they were going into the FC. We expect and what we are seeing so far points to the banks being part of the solution – being able to facilitate lending to consumer, small businesses and corporations.
• And I think we have a better roadmap or line of sight for how this economic downturn ends compared to when we were in the depths of the financial crisis.

We’ve never seen anything like this, right? It’s never been this bad before, how long will it take to recover?

• Not at all. Yes, the rapidity of the decline (discussed earlier) indicates we were collectively surprised by not only the severity of the pandemic, but the draconian public response to it as well. This has made the sudden magnitude of the economic shutdown even more stark.
• In effect, we’ve jammed a whole depression’s worth of pain into 3 or 4 months. The good news is that this sudden drop implies a quite sudden rebound when we emerge from this medically induced coma.

When will we start to see the end of extreme day-to-day stock market volatility?

• Just to touch on volatility levels for a minute, we saw equity market volatility levels surpass those at the peak of the financial crisis and rival levels we saw in the 1980s. So, it has been a wild ride in any context.
• We have seen the volatility index decline by about 45% since the mid-March peak so that could be a sign that things are calming down
• I also tend to follow how hedge funds and a lot of these trend-following, momentum-based strategies are positioned. A lot of these strategies are not making fundamental investment decisions, they are following trends and chasing market momentum.
• There is a ton of capital allocated to these strategies and they tend to move markets when they flip from buy mode to sell mode or visa-versa.
• They were very bullish in mid-February, i.e. much higher than average exposure to stocks
• They have since moved to bear positioning i.e. much lower than normal exposure to stocks
• Points being – we think this move contributed a great deal to the volatility and that, a lot of the selling pressure could be behind us since so much selling has been done already.

Several foreign companies (mostly banks) have already suspended shareholder dividend payments, and some US firms may be forced to do the same.  How safe are my dividends?

• This is very much dependent upon the length of the national shutdown. The longer it goes, the more the odds of cuts by individual companies increase.
• Those firms that are more financially or operationally leveraged are more likely to cut. That said, there is no “typical” profile for dividend cuts. Any company that takes a government bailout will likely have to cut dividend payments. Many firms in the cruise, hospitality, airline, and oil industries will likely be forced to cut.

I’ve been hearing there might be a problem with bonds.  Are my bond funds okay? 

• So, our focus is primarily on high-quality IG corporate and high-quality municipal bonds, so less stress than other segments such as high-yield bonds or segments of the energy market
• But as always, important to do the credit work, the credit analysis and to know what you own. Which we are doing in this environment, in any environment.
• And that applies to whether you own individual bonds or bond funds
• And again, not that it necessarily applies to our fixed income investment process, but the Fed’s recent actions have certainly helped with some of the liquidity issues and stresses in the fixed income markets.

With interest rates at/near zero, how do we get any yield out of bonds?

• Couple of points here – I think this question plays into the tough decisions that a lot of investors are grappling with – not just us individual investors, but pension funds, endowments, etc.
• How do you meet any reasonable long-term return objectives with such low interest rates?
• Do you accept these low rates, low returns or accept the volatility associated with stocks in search of higher returns? Situation really highlights the Fed’s actions and in which direction they are trying to nudge investors towards.
• Very difficult to meet anyone’s goals with a 0.7% yield on a 10-year Treasury bond, especially factoring in taxes and inflation.
• We don’t have a magic solution for the problem, but it’s a good example of why it is so difficult to shun growth assets like stocks.
• With that said, at least right now, yields on very high-quality municipal bonds look fairly attractive compared to Treasuries and solid IG corporate bond yields are also significantly higher than government bonds. So those are some of the areas where we see some relative value in fixed income markets.
• But no silver bullet, a balanced approach in-line with goals and risk tolerance seems like the best solution.

Our Strategies and Tactics

Has the firm ever contemplated moving a notable portion of client portfolios to cash?  Why or why not?

• First – we firmly recognize that this volatility and market declines are extremely uncomfortable. And it would be much more “comfortable” to raise a bunch of cash – preferably before the market declines, wait for all the bad stuff to pass us by and then start investing again.
• Unfortunately, that’s not how markets work. The one point I have been stressing with clients is that – markets don’t wait.
• They don’t wait for all the negative headlines to stop, or for the economy to stop getting worse and start getting better
• Markets are forward looking animals – they price in the risks, uncertainties and potential negative outcomes, often overshoot to the downside – and then move on
• Historically, markets have often bottomed YEARS before the problem that is causing the market stress stops
• And when markets transition to the “move on” phase, the move is often violent and to the upside
• So, while it sounds great to try to sidestep the volatility, in reality – what that usually translates into – is investors selling stocks after a massive decline and buying back in at higher levels.
• I think history shows us how difficult or more appropriately – impossible it is for investors to sidestep these periods of volatility.
• Looking back at the last 40 years, 30 of those years produced positive returns – great batting average fore equity markets.
• But we have seen 8 periods over those 40 years where there has been an “intra-year” decline of 20% or greater.
• If we look at the average “intra-year” decline over those 40 years, it has been almost 14%
• We think a much more appropriate approach is to adhere to the well-thought out investment plan and strategy. And that investment strategy needs to be one that investors can follow in great periods like 2019 when the market is up 30%+ and one that clients can also stick to in periods of stress, like the current environment.
• Deviations from the plan can derail a well crafted, long-term investment plan or strategy. And history tells us there will be plenty of opportunities for deviations.

The market will probably go down more before this gets better. Should we raise some cash and then buy stocks when they are lower?

• I just gave a long-winded answer to a similar question, so I’ll keep this one a bit shorter.
• Perfectly logical strategy if you KNEW markets were going lower, if you would have deployed that strategy on March 23^rd, you would have missed a 22% rebound over the last 2 weeks.
• I don’t think this is an environment that investors are going to be able to “time”, not like there are any environments when that timing is easy.
• Think a much better approach is to be patient and be willing to buy great businesses at great prices when the market presents you with such an opportunity and that is how we are approaching this environment. We think it is the right approach over the long-term.
• Investors’ should remember their time horizons and those time horizons aren’t measured in weeks, months or quarters.

What steps have been taken to potentially protect clients’ portfolio assets and long-term financial planning goals?  Along the same line, what are the plans for the weeks and months ahead?

• The most important protective steps have already been taken – in the form of a financial plan and asset allocation which allows you to sleep at night and avoid worrying about where future cash flows will come from.
• The plan for the weeks and months ahead is really no different than the plan for the last 6 months or the last 6 years. Recognize that the stock market goes haywire about twice a decade, and your plan is designed to weather such periods. One way to mess it up is to radically change it in periods of maximum stress – such as today.

What are you doing to take advantage of the market?  Are we buying anything?

• Started to do some buying in the middle of March as we felt that the fear and panic translated into a disconnect between a lot of stock prices and the underlying long-term fundamentals.
• I’d describe our buying as measured and patient, some rebalancing positions up to target weights, some increasing allocations and adding new positions.
• Going forward, we don’t plan on chasing market rallies, but we have a list, we have a plan and if we see another opportunity where fear and panic creates another attractive buying opportunities, we have a plan ready to go.
• If that situation unfolds, we don’t expect it to feel comfortable, but we think it is the right path

What strategies/tactics are being employed on the fixed income side of clients’ managed investment portfolios during these challenging times?

• First the process or our focus hasn’t changed a great deal
• Maintaining a short duration stance, not buying long maturity bonds, historically low interest rates are not an ideal backdrop for accepting the interest rate risk associated with long maturity bonds
• Core of our fixed income exposure is allocated to investment grade corporate bonds and high-quality municipal bonds, none of that has changed
• We continue to work through the credit analysis process when we buy bonds
• And we are applying the same process to the bonds that we already own, and as always, looking at the risk-to-reward tradeoff
• Have sold a few bonds recently. Not situations where we necessarily saw defaults or bankruptcies as the most likely outcome.
• But also recognize that risk has increased in several sectors and made specific decisions to reallocate to areas where we see less stress going forward.

Are we thinking of selling underperforming stocks and buying stocks that may recover faster?

Yes, we are looking to upgrade portfolios during the decline. We’re looking to sell names which have underperformed or held up better because of their (less cyclical) business profile. In some cases, we’re also adding companies which have been on our “wish list” but out of our buy range because of high valuations.

Miscellaneous 

With the amount of money being added to the government balance sheet, is now a good time to get into Bitcoin/other cryptos?

• Will be perfectly honest here, not something that I understand very well
• Would rather allocate clients’ capital towards owning great business at attractive prices
• Businesses that are guided by strong management teams and that will be able to grow their revenue and earnings stream over time, able to pay us dividends and grow their dividend payments over time
• Again, no expert but seems like the performance of bitcoin correlates really well with investors’ tolerance for risk, do very well when investors have a high appetite for risk and poorly when the opposite occurs.
• Doesn’t seem to meet the definition of a solid portfolio hedge.

Will I pay less taxes this year because the market is down?

• You may. We generally have not taken significant capital gains year to date in client accounts, and there may be losses available for harvest later in 2020, depending upon how rapidly the markets recover from the decline.

Do we have any stocks in our portfolios that could go bankrupt because of this?

• We have always focused on the “best of breed” companies, ones that can not only withstand a downturn but come out stronger on the other side
• So, I would say my concerns are more centered around does management make the right long-term decisions, what does the earnings picture look like next year and the years beyond, how long does it take for the stocks to recover.

Should I be buying gold?

• Only if you believe hyperinflation is a real possibility. The recent and historically unprecedented increase in the Fed’s balance sheet is giving us reason to study this possibility more closely. Stay tuned.

Is my money market safe?

• In a word – yes. The risk profile of U.S. money market funds has improved immensely since the 2008-09 debacle. Specifically, the ratio of U.S. Treasury investments to total investments has more than doubled in the intervening decade – makinghttps://www.fortpittcapital.com/contact/overview/ them less risky.

Any additional questions are welcome. You can contact our offices by clicking here. 

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