A massive tug of war is raging between the the U.S. Federal Reserve (Fed) and the Coronavirus on a daily basis to influence markets and investor psyche. The economic recovery hinges on consumer spending, which is in turn dependent on a resumption of normal life for people all over the world.
In the U.S., shelter in place and the concept of quarantine is being brushed aside by folks who have been cooped up for three months or more. In June 2020, markets experienced a roller coaster decline of 5-10%, depending on the tracking index, caused by rising COVID cases. Florida and Texas had cases surge a month after relaxing lockdown restrictions and cases are rising in states that opened up only a few weeks ago.
For Fed and government stimulus efforts to take hold and give the economy a much needed boost in growth, people need to feel safe to resume normal activity. It seems we are in God’s hands for now as we get more clarity on the direction the virus takes. As we see it, we need three things to happen to get a positive outcome:
We need to make it through the summer and early fall without a significant increase in virus cases, hospitalizations and deaths.
We need investors to continue to buy into the Fed’s storyboard, that they can save the economy and by extension the markets.
We need the heroic effort of pharmaceutical companies and governments to give us a vaccine by the Fall that’s safe and works to prevent serious illnesses and death from COVID-19.
In the meantime, protecting capital from large potential losses should be an investor’s first priority. Before we get a clear indication that the danger from the virus has been contained, we would expect significant volatility. Markets will need to digest shutdown-induced economic and corporate profit declines not seen since The Great Depression.
With so much to worry about, we fully expect there to be significant risk to the downside, but markets should enter a new powerful bull market cycle by year end or early next year fueled by massive monetary and fiscal stimulus. This is probably the greatest “don’t fight the Fed” moment in history. With unprecedented stimulus that may exceed $10 trillion when all is said and done, you won’t want to miss the bull market that follows. It ought to be a doozie!
It’s Worth Saying Again: Don’t Fight the Fed
This market seems completely disconnected from economic and corporate fundamentals, baffling professional and individual investors alike. Pretty much everyone knows the GDP growth is going to crater due to Coronavirus lockdowns. A wide swath of corporate America will likely post the worst drop in corporate profit since the Great Depression. Fundamentals are supposed to help determine a stock’s price in the marketplace. Yet the Fed monetary policy has disrupted the normal functioning of the markets since the 2008 Financial Crisis when they first unleashed their zero interest rate policy (ZIRP) and quantitative easing (QE) (Figure 1). The Fed’s influence has done nothing but grow as they have jumped in to pump up the economy, consumer confidence, and spending with trillions in capital to avoid deflation or depression.
As we continue to deal with COVID-19 health and economic risks, we imagine markets will remain volatile well into the next few years. With the amount of stimulus from the Fed and government, investors could choose to stay optimistic and ignore ugly economic and corporate conditions. Alternatively, sentiment could turn from overly optimistic to negative.
It’s time to be careful with your capital. Many years ago, a noted economist I followed shared a pearl of wisdom – don’t chase the last 5% return that may be left in the bull cycle. We are near all-time market highs and there may not be a lot of upside left in the near term, but there sure is plenty of downside risk.
Figure 1
Source: WBI
I don’t know about you, but I find the current situation very disconcerting and I’d like to know what the future looks like with a little more clarity. Many questions jump to mind that are important and need answers:
Will the Fed ever be able to back off from these extreme policies?
When will markets begin to function normally without Fed control?
How will the tremendous debt be repaid?
Will future generations suffer from an economy weighed down by massive debts?
Will Social Security, Medicaid and Medicare cease to exist because they will cause the U.S. debt to explode further as more people retire?
These are tough questions for central bankers and politicians to answer, but we need real solutions from people in a position to make the changes needed. Courageous action is required by people who are willing to work exclusively for the benefit of the American people. Politicians are constantly pointing the finger at others who are in a position to lead and foist upon them the fiduciary responsibility they are required to uphold when sworn into office. Let’s not forget this as we evaluate candidates for office during this year’s election season.
Markets in Review
With markets flying off the March market bottom in the second quarter, it’s important for investors to keep in mind the scary drop in March of 35-45% from all-time highs. The record drop is a reminder of just how dangerous the Coronavirus-damaged economy and corporate landscape is right now. We know the Fed backstop is firmly in place and with repeated massive monetary policy stimulus and government fiscal stimulus programs the markets recovered some of what they lost in the first quarter. The S&P 500 fell by 33.92% from the February 19th high to the March 23rd low and then reversed course to post a 38.57% gain by the end of Q2, leaving it down just -4.04% YTD (Figure 2). The Dow fared a bit worse, following the market roller coaster down and then up with a YTD decline of -9.55%.
Growth and technology stocks, as measured by the NASDAQ, fared much better after falling slightly less than the S&P 500, -30.11% from the February high to March low, but rallying strong to a gain of 12.11% YTD through 6/30. Value-based investments continued to underperform growth-infused broader market indexes. The Russell 1000 Value large-cap index ended the 2nd quarter down approximately -17% and the Russell 2000 Value small and mid-cap index held onto larger losses of -24.38%.
U.S. fixed-income assets as measured by the Bloomberg Barclays U.S. Aggregate TR Index benefitted the Fed’s easy monetary policy and stimulus, ending the second quarter up 6.14% for the year.
Figure 2: Performance as of 6/30/2020
Source: Bloomberg
Looking Ahead
With COVID-19 cases rising, it is tough to read the crystal ball with any clarity. So far, investors are looking through all of the global and domestic strife and risk already incurred or likely to materialize over the next 6-12 months. When risk is high it pays to have capital protection at the forefront of your investment plan.
As I sit here and try to come up with something brilliant to say, an old Kenny Rogers song “The Gambler” comes to mind and seems particularly apropos right about now. “You’ve got to know when to hold them. Know when to fold them. Know when to walk away. Know when to run.” In investing, as in gambling, getting the “knowing” right is the tough part.
We tend to “hold them” too long, chasing returns even though underlying market fundamentals are telling us to walk away. We tend to run only after our capital has hit the skids and we lock in big losses. And we tend to then sit on the sidelines afraid to reinvest as the bear market trend abates and the next bull market run is beginning. It helps to remember that to win at investing you need to buy low and sell high. Valuations were high before the virus cratered the economy and destroyed corporate profitability for most companies, so the first part of the equation “buying low” is tough to do right now.
As you know, WBI seeks to manage the risk to capital under all market conditions. We are confident our risk protection program will work to reduce losses, as they have in the past, in the event investors stop believing central bankers have a cure for the virus invested economies around the world.
IMPORTANT INFORMATION
Past performance does not guarantee future results.
The views presented are those of Don Schreiber, Jr. and should not be construed as personalized investment advice or a solicitation to purchase or sell securities referenced in the Market Commentary. All economic and performance information is historical and not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product referred to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from WBI Investments or from any other investment professional. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation, you are encouraged to consult with WBI Investments or the professional advisor of your choosing. All information, including that used to compile charts, is obtained from sources believed to be reliable, but WBI Investments does not guarantee its reliability. Sources for price and index information: Bloomberg (unless otherwise indicated). WBI Investments pays a subscription fee for the use of this and other investment and research tools. WBI Investments and Bloomberg are not affiliated companies.
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WBI managed accounts may own assets and follow investment strategies which cause them to differ materially from the composition and performance of the indices or benchmarks shown on performance or other reports. Because the strategies used in the accounts or portfolios involve active management of a potentially wide range of assets, no widely recognized benchmark is likely to be representative of the performance of any managed account. Widely known indices and/or market indices are shown simply as a reference to familiar investment benchmarks, not because they are, or are likely to become, representative of past or expected managed account performance. Additional risk is associated with international investing, such as currency fluctuation, political and economic uncertainty.
Annualized Rate of Return is the return on an investment over a period other than one year (such as one quarter or two years) multiplied or divided to give a comparable one-year return.
The Dow Jones Industrial Average (DJIA or “The Dow”) is a price-weighted average of 30 of the largest and most significant blue-chip U.S. companies.
The S&P 500 Index is a float-market-cap-weighted average of 500 large-cap U.S. companies in all major sectors.
The NASDAQ Composite Index (NASDAQ) is a market-value weighted index of all common stocks listed on NASDAQ.
The Russell 3000 Index is a float-adjusted market-cap weighted index that includes 3,000 stocks and covers 98% of the U.S. equity investable universe.
The Russell 1000 Index is a float-adjusted market-cap weighted index that includes the largest 1,000 stocks by market-cap of the Russell 3000 Index.
The Russell 2000 Index is a float-adjusted market-cap weighted index that includes the smallest 2,000 stocks by market-cap of the Russell 3000 Index.
The Russell 3000 Value Index uses the value characteristic book-to-price ratio to create a style index based upon the Russell 3000.
The Russell 1000 Value Index uses the value characteristic book-to-price ratio to create a style index based upon the Russell 1000.
The Russell 2000 Value Index uses the value characteristic book-to-price ratio to create a style index based upon the Russell 2000.
The Barclays U.S. Aggregate TR Index is calculated based on the U.S. dollar denominated, investment grade fixed-rate taxable bond market including treasury, government-related, corporate, MBS, ABS and CMBS debt, and includes the performance effect of income earned by securities in the index.
The Barclays Global Aggregate TR Index is calculated based on global investment grade debt from twenty-four local currency markets including treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging market issuers and includes the performance effect of income earned by securities in the index.