2020 First Quarter
When I visited my accountant in the middle of March to discuss my corporate tax return, he asked me how things were going. I grumbled something about my disappointment in the extremely volatile stock market. He probably knew what I was going to say and quickly responded, “Bill, stocks go up and stocks go down.”
Of course, this is absolutely true and I appreciated the reminder. We know from recent history that stocks don’t climb in lockstep - they can go down as quickly or sometimes even faster than they go up. All a financial history buff would need to do is go back to the troubling days of the Great Recession in 2008 and 2009 with the real estate bubble or the dot-com bust in the early 2000’s. Bubbles appear and then they are pricked. But this sell-off is different. Most analysts would argue there was no bubble this time. Stocks were expensive with a forward P/E of 19 at the beginning of the year when 15 is the average, but this isn’t outrageously expensive. Janet Yellen, the former Federal Reserve chair, even said on CNBC a week ago that this time was different than the Great Recession in that we had a strong economy going into the COVID-19 outbreak.
At the beginning of the coronavirus outbreak, I thought the US would experience a few weeks of a massive shutdown, but we would be on our feet quickly thereafter. I was thinking it would look like a “V” shaped recovery. As the days wore on, we realized this was a several month process…perhaps even longer. Predictions of hospitals being overrun and tens of thousands dying filled the newspapers and cable news shows. The market reeled. How can investors contemplate the net present value for a set of future earnings streams that are non-existent for the next one, two or three quarters? Sure there could be pent up demand for cars and folks will want to eventually take their vacations, but how quickly will consumers return to restaurants or movie theaters when they re-open after practicing social distancing for months on end? I’m guessing most people will take a cautious approach and will not simply return to sporting events or concerts until they know they will be fine – whether that is through a successful treatment that stabilizes the sickest patients (see Gilead Sciences and remdesivir) or the eventual success we will hopefully find in a vaccine – which could be 12-18 months away.
So, what is an investor supposed to do? I believe it boils down to when you will be needing to tap your investments for cash. For example, for those of you who take monthly distributions for living expenses, I set aside approximately six months of withdrawals in the money market. If we need to replenish the money market I have been and will continue to primarily sell your short-term bonds. Some of you have called and asked me to trim your equity exposure for either a larger than normal distribution or to slightly lower your equity exposure during this time of uncertainty. That is fine – I do not want any of my clients losing sleep over their investments. As my dad, who died at the age of 46 from an asthma attack used to say, “Your health is #1.” Let’s make sure our focus is on our own health and the health of our loved ones through this pandemic. As for your investments, the allocation of stocks to bonds should be our priority. Our equity allocation should be invested for the long-term – at least five years. Why five years? Because it can sometimes take five years or more to ride out a large drop in stock prices. If you have questions about your stock-to-bond allocation, please do not hesitate to contact me.
For those of you with more than five years until retirement: This is your time to purchase stocks selling at a discount compared to the February 2020 all-time highs that were reached. With the forward P/E ratio at 16.1, we are certainly a lot more reasonable today than we were at the market highs. If you are contributing to a 401(k) plan, consider increasing your contributions. If you have thought about opening a Roth IRA, now is the time! If you had earnings in 2019, you may qualify (depending upon your income levels) for a Roth IRA contribution for 2019. Due to the extended tax filing deadline, we now have until July 15th to contribute to a Roth IRA for 2019. Let us know if you would like to open a Roth IRA or if I can help review your 401(k) allocation.
When I look back over the past several weeks of the stock and bond market volatility, I believe there are two things that prevented a steeper sell-off than what we have experienced. The first was the Federal Reserve stepping in and doing whatever they could to free up credit and cut short-term lending rates. Originally, they announced a $700 billion asset purchasing program that would pretty much buy any type of bond – corporate, high yield, etc. Then they increased this limit to “unlimited.” They basically stepped in and did everything in their power to save the economy. Congress and President Trump created a $2.3 trillion Coronavirus Aid, Relief, and Economic Stimulus or CARES Act that will hopefully help address main street businesses as well as provide ordinary citizens with some cash relief to buy some time while many go without paychecks. Taken together, these unprecedented moves helped stave off a deeper recession than what we are currently in.
By the way, I have attached the Vanguard executive summary for the CARES Act for your perusal. Within this act, you will note that there is a waiver of the 10% early withdrawal penalty. Also, there is a temporary waiver for those of you taking required minimum distributions (RMDs) from their IRAs. Throughout the year, we will be contacting those of you taking RMDs to see if we should suspend them for this year or if, indeed, you would want them to continue. Typically, these distributions take place in November/December.
The other thing that prevented a steeper sell-off than what we have experienced is the flattening of the coronavirus curve itself along with the efforts of the testing to make the invisible, visible. If you ask me, the government has done what it could do. Sure, there are calls for another round of stimulus - particularly helping the state and local municipalities that rely on sales tax for their revenue (i.e. retail sales are non-existent right now). But I firmly believe the market will respond best to a continued flattening of the coronavirus curve along with more and more testing as workers begin to enter the workforce. As the curve flattens and as authorities begin to “see” via the testing where the biggest impacts are and can react to those areas, the sooner the consumer will feel comfortable going back out into the world. Should we fail at tamping this down, we could have another explosion of the virus in late summer that would certainly send us back to our homes again. The question at that point would be: Does Congress have another $2.3 trillion to spend on stimulus? Let’s hope we nip this in the bud now and hopefully we will have some treatments sometime soon.
As for the near-term outlook, no one knows what is going to happen tomorrow, next week or three months from now. I can tell you that we are at Great Depression levels of unemployment, but will we be at these same levels three years from now? At this point, many analysts are pointing to a “U” shaped recovery. After all, our Federal and state governments could open the economy up tomorrow, but does that mean everything will be back to normal? Of course not! Thus, the “U” shape. I’m hoping that the strength of our economy going into this fiasco will have an impact on how long we are down. I am hoping for something between a “U” and “V”. I plan on reaching out to all of you to see how feel about your current allocation. 10 years from now, I am certain stocks will be higher than they are now. I also believe stocks will outperform bonds over the next 10 years. I am not as certain about the next 10 months. Perhaps we will retest our lows. Perhaps we will climb higher from here. There are so many unknowns, so many variables. In the meantime, let’s make sure we are on the same page regarding your asset allocation. Please call me with any concerns or questions.
As Janet Yellen alluded to in that recent interview, we will be stronger - not for the debt we are taking on - but from the realization that pandemics are a new enemy. With a renewed focus on health care and a better coordinated global approach to combating future virus outbreaks, the US and countries around the world will be stronger. Hang in there and stay safe!