Highlights:
· Despite news that continues to be discouraging, global equity markets surged during the quarter on optimism that the worst of the virus-induced economic lockdown is behind us coupled with accommodating monetary and fiscal policies that are likely to remain in place for the near future.
· Policymakers continue to deal with a balancing act between curbing the spread of the virus and bolstering economic activity; early results show the U.S. faring considerably worse than much of the rest of the world.
· The investment policy we espouse is designed to help investors manage uncertainty surrounding events like the pandemic and deal with the inherent volatility of the equity markets.
Commentary:
“Our inability to know the future is a theme we’ve touched on repeatedly over the years and with little or no history that’s relevant to the current situation you really can’t say we know how it’s going to turn out. No one can succeed consistently in predicting things that are heavily influenced by randomness and otherwise inconsistent.” -Howard Marks, Oaktree Capital Management
The second quarter saw global equity markets stage a remarkable recovery from the first quarter’s decline. Stimulus from central banks and governments across the world, coupled with the relaxation of some COVID-19-driven economic restrictions, triggered the market rebound. Unfortunately, strong equity market returns were sharply in contrast to news that continues to be devastating. As of the writing of this report, there are over 13 million confirmed worldwide coronavirus cases and over 575,000 confirmed deaths. The number of workers that have filed for unemployment insurance since the pandemic began is staggering, with over 40 million Americans alone having filed for benefits since March – the fastest and largest filings of job losses on record. There is no historical comparison for the speed of this job destruction. The damage being done to our economy by this health pandemic, with billions in sales already lost, will be unlike anything most of us have experienced in our lifetimes and will take a long time to repair. Reopenings that have been paused or rolled back may make things worse before they get better. To make matters worse, our country is in the midst of civil unrest on the heels of the death of George Floyd that has led to the very large gatherings of people that state governments are trying to avoid to prevent the spread of COVID.
How can it be that stocks are soaring when public health and economic news continues to be so overwhelming? The answer is likely less about economic optimism and more about financial markets being awash in money because of moves made by central banks and governments across the world. As the saying goes, “don’t fight the fed.” Since March, the Federal Reserve has committed to lend or buy trillions of dollars of financial assets, the Bank of Japan is doing much the same for the world’s third largest economy and the European Central Bank is not far behind. In addition, Congress has allocated almost $3 trillion in economic aid and multiple governments around the world are following suit.
Central bank actions may be sufficient to keep the economic crisis from becoming a financial system crisis, but this pandemic remains at its core a health crisis, for which central banks have no direct tools. There is nothing normal about the nature of this cycle and no playbook for dealing with a health crisis that morphed into an economic crisis by virtue of government-mandated lockdowns. Policymakers continue to be faced with a difficult tradeoff between health uncertainty and economic uncertainty. We do not believe it is realistic to think the world can stay in lockdown mode until a vaccine is developed and mass-produced at scale to inoculate the entire global population. Many viruses never have a useful vaccine, and those that do typically take several years to develop and even then are usually only partially successful. On the other hand, it is crucial to safeguard public health and find a way to prevent a new wave of contagion strong enough to overwhelm health care systems.
The most visible effect of the money in motion is currently the stock market, but over time, more Fed money should flow to the states and general population. For instance, the Fed is committed to purchasing hundreds of billions of dollars of municipal bonds at favorable rates, which means that cash-strapped state governments should be able to retain teachers, police officers and other government employees. That should further indicate that pensions for public servants remain intact. In addition, the U.S. House recently passed an extension of the $660 billion Paycheck Protection Program, which, assuming it is signed into law by President Trump, will hopefully buy the time needed by many small businesses to allow them to stay solvent and eventually re-open at more full capacity and re-hire. Nevertheless, it is inevitable that some businesses will never recover from this pandemic and go permanently out of business.
If policymakers are successful in restarting the economy over the next couple of months, the massive policy stimulus in the pipeline can fuel a robust economic recovery. However, if initial steps to reopen the economy are reversed, the structural damage to the economy could be considerable. Massive unemployment, deepening economic hardship and growing insolvencies will not be fully remedied by partial re-openings or government interventions alone. The longer that economic activity remains suppressed and the longer that workers go without incomes, the more difficult it will be for consumer spending to rebound and the more entrenched the economic damage will become.
Early results coming out of states that re-opened first like California, Florida and Georgia are not encouraging. This is consistent with growing evidence that countries that enacted swift, strict and uncompromising coronavirus measures have been more successful with re-opening their economies without a resurgence in virus cases. The U.S. reacted too slowly to prevent an initial outbreak and then took an approach of delegating virus response measures to the states. This led to a wide disparity in virus control measures, from states that enacted total lockdowns to states that did almost nothing at all. Many parts of the country then declared victory prematurely and resumed activity in ways that spread the virus and risk delaying a true economic recovery. This has the U.S. starting to look like an outlier, with much of the rest of the world slowly moving back toward more normal functioning without setting off major new outbreaks.
While equity markets are clearly not reacting to real-time economic fundamentals, they do appear to be moving based on reasonable judgements of forward-looking fundamentals and distinguishing between industries that look to be hardest hit from those that might even benefit from the economic dislocations that COVID-19 responses are creating. Stocks are not going up in unison; rather, to date, there has been a difference in how individual companies are faring based on investors’ perceptions of how they will do in a pandemic world. For example, tech behemoths Amazon and Microsoft, along with video conferencing software Zoom and bleach manufacturer Clorox have been big winners, while retail stores spread across malls, airlines, hotels and energy companies have suffered.
Therefore, while on the surface it appears vey counterintuitive that equity markets are doing relatively well while the world economy seems to be in shock, there is some rationale that reflects potentially positive realities of an otherwise dire time. If nothing else, this is a reminder that as bad as things are now, they actually could be considerably worse. The same could be said from a medical perspective. When this pandemic first broke out in March, we did not know how deadly the disease was, what its side effects were, or what kinds of treatment might be effective. As time has gone on, science advances, death rates have been declining, testing has increased and medical professionals seem to have at least a slightly better grasp on how to treat the virus.
As has been the case historically, when we come out of the depths of this public health pandemic and economic recession, there will likely be new engines for growth. Some economists believe the U.S. is in the midst of transitioning to an economy that will be less dependent on consumers, whose spending currently makes up two-thirds of U.S. gross domestic product (GDP), and more dependent on investments, such as housing, manufacturing, technology and, of course, healthcare. China’s descent and the United States’ ascent as a cost-effective place for business investment is one example of a trend that could lead to a shift toward investment over consumption in the U.S. down the road.
The world is an uncertain place on the best of days and might be even more uncertain today than at any other time in many of our lifetimes. Economic and stock market recoveries rarely proceed in a straight line and its path this time is even more unpredictable than usual. This path is likely to be strongly correlated with the effectiveness of measures needed to halt the spread of the coronavirus as the global economy continues to re-open. The investment policy espoused for your portfolio is designed to manage uncertainty by insulating your portfolio with cash and fixed income positions intended to meet your anticipated portfolio withdrawal requirements for nearly a decade at all points in time. This determination is based upon a review of a comprehensive analysis of your cash flow requirements. Using this approach, we are conceding that the world is inherently uncertain and as a result, equity markets are inherently volatile. The long-term orientation of the growth component of your portfolio is thus purposefully designed to rely on time and to avoid market timing. As French philosopher Voltaire said more than 250 years ago, “Uncertainty is an uncomfortable position. But certainty is an absurd one.”
Urban Financial Advisory Corporation – July 2020