03/26/2020

The speed at which the COVID-19 crisis is playing out is extraordinary.  Market movements that have historically taken weeks and months, now occur in hours - if not minutes.

In my note to you this past Tuesday, I observed: "Perhaps, when looking back at this crisis the silver lining to it all will be found in the speed at which everything happened.  Once everything is shutdown, there is nowhere to go but up. Just as rapidly as our economy unraveled, it is entirely possible Americans will race back to normalcy once that becomes possible."  

It appears the time to capitalize on the attractive valuations created by the crash in market prices is approaching rapidly.  Two of the three elements we believed were necessary for the markets to stabilize have materialized in just a few days.  First, was the Federal Reserve's commitment to backstop U.S. capital markets with unlimited liquidity.  Second, was an enormous fiscal relief program from Washington.  This legislation is working its way through congress and is expected to be finalized very soon.

The third and final piece of the puzzle has to do with the question of reopening the U.S. economy.  The answer to this question will be determined by the data trends of the COVID-19 virus itself and this remains largely unclear.   If the shutdown begins to wind down in the matter of weeks, a strong rebound is likely.  If the shutdown last for several months, the economic damage could be more challenging.

While it is still too early to forecast when the number of new cases of the coronavirus will peak in the U.S., there are reasons to be optimistic.  It is believed that the U.S. outbreak is trailing other key countries by two to three weeks.  If our trajectory follows the favorable trend of South Korea, for example, we would expect to see new COVID-19 cases in the U.S. peak mid-April.

The hope now is that parts of the U.S. economy would begin to come out of shutdown around Easter (April 12), as the President has suggested might be possible.  If this is the case, the worst of the market collapse has already happened, or will happen over the next couple of weeks.  In other words, the bottoming process I have written about could be progressing quickly and the window of opportunity would likely peak in the next several weeks.

Though the COVID-19 data trends are uncertain at this time, current valuations in the market are compelling.  Based on measurements such as trailing price-to-earnings multiples or earnings yield, equities are unusually cheap right now.  Value and dividend paying stocks look particularly attractive. 

We strongly believe markets will eventually reach new highs, even if we do not know how long it will take.  It we assume that U.S. equities would need three years to return to the February highs, the average annual return would be 17% from current levels.  If the assumption was that it could take five years to fully recover, the annual return would be about 11%.  Given the strength of the U.S. economy coming into this crisis and the ingenuity of the American people, it is difficult for us to believe a resurgence of our economy and the capital markets was out of reach.

Clearwater Capital has initiated the first of several steps designed to capitalize on this opportunity.  This said, it is premature to declare that the final lows are in for the markets.  A bottoming process has likely begun, and we expect to see more positive developments evolving over the next four to six weeks.  Equity markets usually turn well before that point in time when the news becomes good.  Rather, stocks generally move higher following steep declines when the news flow simply begins to become less negative.

Our positioning of portfolio strategy for a recovery will be an incremental process taking place over time.  We recognize that volatility remains high and not all our steps will be perfectly timed.  While this might result in short-term frustration, we are confident the long-term results will be favorable.

In November 1942, following the British victory over German forces in North Africa, Winston Churchill famously said "Now this is not the end.  It is not even the beginning of the end.  But it is, perhaps, the end of the beginning."  This decisive battle led to the German surrender in North Africa in May 1943.

Turning points during times of crisis are only certain in retrospect, long after the crisis subsides.  We must remain braced for more bad news; especially as the economic impact of the COVID-19 outbreak deepens.  This said, the economy will ultimately recover, and markets will stabilize before the economic recovery is evident.  Patience and perspective will be critical as we work our way through this historic time.   

Best,

John

PS.  For investors wishing to capitalize on the current opportunity using excess cash reserves, now would be the time to initiate deposits and/or transfers to Clearwater Capital Partners.  Please let us know and we will assist you with these money movements.

John E. Chapman