04/01/2020

Thankfully, today is the first day of a new month and a new calendar quarter.  For U.S. stocks the quarter we just completed was the worst quarter since the financial crisis (2008).  That is the bad news, the good news is that markets have been attempting to stabilize over the past five trading days.  In fact, over this period U.S. equities have recovered about 8% - 10% of what was lost in the recent selloff.

April has historically been the best month of the year for the Dow over the last 50 and 20 years.  Over the last 50 years, the Dow has averaged a gain of 1.89% in April with positive returns 66% of the time.  Over the last 20 years, the Dow has averaged a gain of 1.87% in April with positive returns 80% of the time (Bespoke).  Let’s hope April exceeds these historical averages for us this year. 

Throughout this crisis we have focused our attention on four distinct areas:  the health and data characteristics of the coronavirus outbreak itself, the impact on our economy, the selloff in our capital markets, and the pressure this crisis has brought to our personal well-being.  As previously noted, these four areas of the crisis will playout in distinct ways according to their own unique timelines.  I will comment on each of these four areas in this update. 

The COVID-19 Outbreak 

We have been carefully monitoring the spread and trends of the virus.  We believe the social distancing measures are effective and we will soon see some flattening of the curve (as is currently happening in Italy and Spain).  Our view is the U.S. is approximately one to two weeks from a peak in the data.  While infection and mortality figures are still rising, we are encouraged by the observation that these global numbers are climbing at a gradually slower rate.

Over the past several days, public health experts have noted that several of the original models forecasting the spread of the coronavirus were skewed toward worst-case scenarios.  Fortunately, these worst-case scenarios have yet to happen.  The geometric spread of the virus (e.g., a doubling of cases every 2 days, as many feared) projected as many as 100 million cases in just two weeks.  While the data has been unsettling, we are nowhere near the doomsday numbers forecast in the early models.

A recent video of Dr. Deborah Birx, Coronavirus Response Team Coordinator, explaining the challenges of modeling the outbreak is very helpful.  This video can be found on Clearwater Capital’s COVID-19 Resource Center (CCP / COVID-19).

In addition to better COVID-19 data trends, we are monitoring a rapidly developing list of therapeutics—led by chloroquine—and the accelerated development of vaccines.  French researchers now claim a combination of Hydroxychloroquine and Azithromycin to be effective in treating COVID-19.  We find this, and the fact that test kits are on the verge of being distributed by the millions, very promising.

The U.S. Economy

It is now widely understood that the COVID-19 outbreak and our social distancing response will have a significant impact on our economy.  Some estimates call for an unemployment rate approaching 15% with GDP shrinking by as much as 25%.   While not unexpected, a wide range of economic reports and data coming our way over the next several weeks will be shocking.  Some of these reports will likely be worse than anything we have ever seen.     

To blunt this downturn, the Federal Reserve and Congress have put together the largest rescue package in U.S. history.  The Fed’s action has already narrowed credit spreads and improved the functioning of the bond markets.  The CARES Act builds on the two former pieces of legislation by providing more robust support to both individuals and businesses, including changes to tax policy.  We can assume further intervention by the U.S. government as the crisis continues (including, but not limited to, a massive infrastructure spending bill). 

Reopening the U.S. economy is the fundamental element of the recovery.  As to when we might see parts of our economy begin to restart, all hope now centers around the end of April - provided improvements in coronavirus data materialize as currently estimated. 

The American Enterprise Institute (AEI), led by Dr. Scott Gottlieb (former commissioner of the Food and Drug Administration), has published report entitled A Road Map to Reopening.  This report explains a phased approach to restarting economic activity in the U.S.   The AEI report can be found on Clearwater Capital’s COVID-19 Resource Center (CCP / COVID-19).

The details and strategies for resuming economic activity in the U.S. will continue to develop as we move through April.  Over the coming weeks we can expect an expanding body of research and government policy that will focus on these critical stages.  Importantly, this shift in the narrative will likely bolster confidence as people begin seeing light at the end of the tunnel. 

The Capital Markets

The sell-off in the capital markets has been as painful as it has been dramatic.  The S&P 500 ended the first quarter of 2020 with a decline of exactly 20%.  In the history of the index since 1928, it was just the 9th quarter that has seen a drop of 20%, and it was the first since Q4 2008 when the S&P fell 22.56%.  Since WW2, it was just the 5th quarterly drop of 20% or more.  Notably, in the six months and twelve months following the prior four quarterly drops of 20%+ since 1945, the S&P was higher every time.  Over the next year, the index was higher by 10% or more every time (Bespoke).

There is no escaping the fact that the first quarter has been as difficult a quarter as many of us have ever experienced.  This said, we believe market volatility has primarily been driven by the great uncertainty surrounding the COVID-19 outbreak.  Markets detest ambiguity and we are only now beginning to collect enough data to understand what we are up against.

Soon we will be able to better quantify how long the economic shutdown is likely to last.  As mentioned above, policies for exactly how the economy is to reopen will develop and the uncertainties will become less overwhelming.  The picture is not likely to be a good one for some time, but we will gradually have a handle on how a recovery will take shape.

While the sell-off has been historic and no one can be certain that the worst of the market volatility is behind us, we believe that the bottoming process is underway.  This too will take time.  Our view is that the initial sell-off overextended to the downside.  Provided the news flow does not take an appalling turn downward, we presume recent market lows will hold.  Markets will not wait for good news to move higher.  Rather, equities generally begin to rally just as the bad news begins to become less bad. 

We must also recognize that favorable developments such as any therapeutic treatment that sharply lowers the mortality rate of COVID-19 will be accompanied by a substantial market rally.  Given the extraordinary resources now focused on the medical response to COVID-19, this possibility is considerably more than wishful thinking.

Personal Well-Being

A financial shock, such as the one we are suffering, has an assortment of planning implications for all investors.  These repercussions must be studied and modeled for each individual household, as the fact pattern is unique to each case.  The complexities of these models are incompatible with hurried or easy conclusions; knee-jerk reactions generally conflict with achieving important long-term objectives. 

We have been evaluating the ramifications of the sell-off for our clients and are actively developing recovery strategies.  This process will take time; however, we are committed to defining a responsible and practical path forward.

Of course, personal well-being is considerably more than fluctuating portfolio values.  We acknowledge the nervous tension we are all feeling, and we aspire to doing everything possible to mitigate the stress and anxiety that are normal in moments like this.  As previously noted, we encourage our clients and friends to take a step back from the constant news coverage and day-to-day vacillations in the markets. 

We are better served focusing on the quality of the investments contained within our strategies.  Over the past several days we added to our portfolios multifactor funds containing names such as Walmart, Microsoft, Intel, and AT&T.  While the share values of these companies are currently depressed, we are confident these values will eventually rebound, and these are the type of companies we want to own long-term.       

Final Thought for Today

As we all continue to process and adjust to this crisis, let us not lose sight of our own personal resiliency, and that of our country.  I remember quite vividly the days, weeks, and months following the terrorist attacks on 9/11.  I recall a profound feeling of anguish for our country.  This was a feeling I had never previously known; it was as though the country would never recover what had been lost. 

News coverage of the attacks was non-stop and, at times, overwhelming.  None of us could escape the images and tragedy of it all.  For an extended period, we feared additional violence from further attacks.  How would we ever again feel safe?  How would we ever get back to what we thought of as “normal”?

Of course, we did heal.  Life as we once knew it ultimately resumed.  It took time and for a long while it was not easy.  Yet, not only did we bounce back, we went on to enjoy many achievements and life-changing innovations.  Oh, and we went on to see the total collapse of our financial system in 2008, and we bounced back from that too.

Crises have a way of shaking our confidence to the core and we find it hard to believe that we will ever find our way back.  With every crisis we are justifiably terrified by the realization that the difficulties we face are unlike anything previously encountered.  And then, we recognize this is true of every crisis – the challenge always feels frighteningly different.  In this moment we must recall the lessons of our own history.  Then, we remember how the story goes . . .  somehow, we always find our way back. 

Take heart.  America is showing up, we are working the problem, and we will figure it out. 

We got this.

John

PS.  As mentioned above, we have created a special Coronavirus Resource Center on our website where clients can review all our commentary and client notes on the crisis.  Also included there are the best third-party reports and analysis we have found.  We are updating these postings daily and I encourage you to visit this website regularly.  You can access these resources here:  CCP / COVID-19.  

Feel free to share this link with friends and colleagues who might find useful perspective and value here.