Where to Begin?
Most importantly, all of us at Gemmer hope you and your family are healthy and doing as well as can be expected. Everyone here is working hard during this ‘shelter in place’ period and our backup plan to work remotely is functioning better than we could have expected. We were fully operational day 1!
Secondly, you may see trade confirms coming through in the coming days. We are not making dramatic portfolio allocation changes, but we are tax loss harvesting accounts. This entails selling a position with a loss and buying a similar position. The portfolio allocation stays the same, but we’re banking a tax loss to carry into the future.
The following note is in no way meant to minimize the turmoil many are going through. For some, the world of investments are the last thing on their mind. But for others who are interested we want to recap some of the major events of the week and share with you some of the things we are reading. We don’t claim to have any great insights on COVID-19 or how this pandemic will play out. Sam Harris, Peter Attia, among others, have some excellent podcasts that cover the topic exhaustively. However, we will try to offer up a balanced take on the global economy and the state of the financial markets. But remember, the situation is changing rapidly, and some of this could be stale come Monday!
The volatility of the last few days is historic – both up and down. Three days this month make it into the top 10 biggest up or down moves since 1926.
And if it feels like this bear market happened quickly – it did. It is actually the fastest bear market in history. It took just 16 days to fall more then 20% from the high. During the financial crisis it took roughly 175 days, as you can see below.
All of this is moving so fast because the global economy hit a sudden stop 7-to-10 days ago as quarantines/shelter in place orders became more frequent.
We won’t go through the specific industry challenges as there are too many to cover, but we should point out the pain in the energy sector. Oil prices fell to their lowest level in 17 years on Wednesday as demand for fuel has been hit hard by work and travel lockdowns. Before Thursday’s rebound of almost 25%, crude had collapsed by more than half in a little over two weeks, as you can see below.
This move is simply going to crush firms in the U.S. shale sector. The chart below is a bit old, but it makes the point that oil prices need to be between $47 and $69 a barrel for domestic producers to even breakeven.
The threat of bankruptcies in this area is unnerving the corporate bond market and is leading to a surge in credit spreads, as you can see below.
Markets Trying to Price an Uncertain Future
It almost goes without saying that a global recession is almost assured at this point. But how deep will the recession be? And what will the recovery look like?
These are awfully hard questions to answer at this point because the situation is rapidly evolving. But one firm’s view comes from J.P. Morgan yesterday. Their estimates are below for the major economies.
Note, with the exception of the far-right column, these are quarter-over-quarter changes rather than the year-over-year numbers we are used to looking at. What jumps out are:
– China is basically a quarter ahead of everyone else. They will see a major contraction in the first quarter (1Q) followed by a significant bounce in 2Q and 3Q. This of course assumes that the growth in new cases follows the encouraging trend shown below (there were no new cases yesterday). But if China can return to work, that argues that the rest of the world can follow a similar course if the right actions are taken
– The rest of Asia is in a similar position, but with a lag. Contraction in 1Q and 2Q and big bounce in the second half. Data from South Korea is encouraging with active cases declining.
– Europe will struggle in both 1Q and 2Q. They are going to be hit twice, so to speak, because trade dried up with China in 1Q and disease containment will probably last through the end of 2Q (to the extent we can guess such things).
– The U.S. will feel the worst of the hit in 2Q before bouncing back in 3Q. Again, timing the bounce is an open question while infection rates continue to increase, but China and South Korea hold out hope.
– On balance, global growth will be barely positive in 2020 per these projections, the worst showing since the financial crisis.
Again, take these projections with a grain of salt, but it at least frames the debate for the time being. And the simple fact the outlook is so uncertain explains much of the recent volatility.
What Do We Need for a 2nd Half Bounce?
Almost certainly the markets are not down more this year because some investors are looking through this tough time towards a second half recovery in global growth. As you can see in J.P. Morgan’s numbers above, they think global growth could be +19.1% in 3Q. The rebound probably depends on the interaction of three forces:
1. The relaxation of social distancing policies before mid-year. Implicit in the forecast is the view that the imposition of aggressive containment measures will cause the number of active infections to peak around 10 weeks after the confirmation of cases in individual countries. The fading of the virus threat, alongside a growing recognition that the economic costs of maintaining aggressive containment policies are very large, should then begin a process of selective removal of containment measures.
2. The success of targeted, coordinated monetary policy changes. One of the positive consequences of the global financial crisis is that central bankers around the world have experience in dealing with acute financial sector stress. As such, they are moving rapidly to attempt to keep the financial markets functioning and are working to cushion the blow to corporations and households most impacted by the shock. Ensuring that credit will be provided by banks, deferring (or cancelling) tax payments, and subsidies for short-time work have been key areas of focus.
3. Fiscal and monetary policy stimulus is building. Usually it is monetary easing that provides the initial line of defense in responding to an economic slowdown. However, with unemployment likely to spike in the days to come people need help with buying essentials, covering rent, etc. We are probably looking at historically large fiscal packages.
The big question that is tough to answer at the moment is whether all three come together in the next 2-3 months to trigger a rebound, or if we are looking at a more drawn out U-shaped recovery.
Kitchen Sink Policy
In the U.S. on the fiscal side, we are seeing progress despite all the noise. Greg Valliere wrote on Wednesday:
“The fiscal response will be just as aggressive…(there are likely to be) three bills
1. The first measure, earlier this month, allocated about $8bn for medical supplies.
2. The second bill, which should win enactment within the next day or two, will allocate about $100bn to victims of the virus – expanded sick leave aid, more generous employment benefits, etc.
3. The third bill, costing a minimum of $1tn, will come into focus in the next week and should win enactment by the end of March. There will be one lump sum payment – probably $1000 per person – this spring, and still another payment is possible in the summer if the virus doesn’t subside.
No one likes the word bailouts, but they’re coming – first for airlines and the tourism industry, but primarily for small businesses. Massive bankruptcies are a major concern in this sector, which will prompt even more stimulus, including loan forgiveness.
4. The third bill may be followed by a fourth cash infusion in the summer, bringing total government aid close to $2tn. The budget deficit in this fiscal year could approach a staggering $3tn – yet the mood among most politicians is that money is no object!”
Of course, it isn’t just the U.S. implementing such plans. Canada announced a $57bn stimulus package, with $18.7bn in direct assistance to help Canadian citizens and businesses. As part of the package, businesses would be given a temporary wage subsidy for up to three months to allow them to keep workers on the payroll, while taxpayers would have until August 2020 to pay their taxes. We have seen similar plans in the U.K. and mainland Europe.
More from Greg:
“A sense of national mobilization has taken hold in Washington and throughout the country. Aside from some clueless idiot kids at Florida beaches, there’s a growing sense of purpose, that we’ll get through this. We’ll look after family and neighbors.
OUR INDUSTRY IS FAMOUS for anticipating what will happen six months down the road, and what we clearly detected yesterday when talking with investors is that a market bottom is within reach — and everyone has a wish list of cheap stocks to buy when the bargain hunting begins.
TO REITERATE, WE’RE HARDLY NAIVE: Outside of Asia, the virus will get worse before it gets better, and people who live check-to-check are scared. But monetary and fiscal policy definitely will “go big” as the government mobilizes with a massive response, unlike anything since the 1930s.”
Charts We Are Watching
In this section we simply want to share charts we come across that we think are interesting or noteworthy:
1) Much is made of the fact we are following in lockstep with Italy when it comes to infection rates. And it seems to be true as you can see below.
However, as Whitney Tilson notes:
“The good news is that we’re 10 days behind, so the actions we’re taking today will hopefully help us avoid Italy’s outcome. Also, note that this chart is tracking number of cases, but we’re a massively larger and wealthier country, with a population 5.5x larger than Italy’s (~330 million vs. ~60 million)…(furthermore) Italy has one of the oldest populations in the world — 23.3% of people are over age 65 — and in many households, multiple generations live together or close by, and interact often. It is becoming clear that the pandemic’s progression and impact may be strongly related to the demographic composition of the population, specifically population age structure.”
2) By now we have all read about flattening the curve to prevent our health system from collapsing. One way to measure this is the number of acute care hospital beds per 1000 people. On this score, the U.S. doesn’t rank very well.
3) So much for the dollar being a doomed currency. During times of crisis what do foreign investors want to hold? U.S. dollars – witness the massive dollar rally over the last few days.
4) Some interesting data from Fuller & Thaler on insider buying (where corporate officers register to buy stock in the company they work for. Typically, they buy when they know the market is unfairly valuing their company.
On the same point, Bill Nygren, a renowned value investor, pointed out the following this week:
“During market corrections over the past decade, we’ve often been asked, “How do the values today compare to those during the Great Recession in 2008?” The answer has always been that while the values looked good relative to history, they were not as extreme as in 2008. Today, I can say that our analysis suggests similar attractiveness. On our approved list of about 120 stocks, all but two are trading beneath our buy target. At Harris Associates, we normally sell stocks when they reach our sell targets and redeploy that capital into those selling at their buy targets. Today as in 2008, we see opportunities to sell a stock at its buy target and redeploy the capital into a stock selling at half of our buy target.”
5) Investors are about as bearish as they have been since the financial crisis. This is typically taken as a contrary indicator.
6) A newsletter I read each day summarized Wednesday’s announcements into COVID-19 treatments. This was just for a single day. You have to be long-term bullish on human ingenuity!!
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