TCM 1st Quarter 2020 Market Outlook and Strategy Update
Stephen M. Mills, CIMA® Managing Partner, Portfolio Manager
Brad Bays, CIMA® Partner, Portfolio Manager
Highlights: The global economy and financial markets have been significantly impacted by the coronavirus. We currently have no vaccines to combat the virus however there are treatments and existing drugs that are being tested and used in reducing symptoms. The U.S. government and Federal Reserve have implemented powerful measures to combat the economic impact of the virus. We present three possible scenarios for the U.S economy and the financial markets.
The coronavirus, which originated in China probably in December of last year, has spread like wildfire across the globe to become a global pandemic. The number of infections, and sadly, deaths, continues to rise globally with the U.S. overtaking China and Italy with the highest number of reported cases. The good news for the U.S. is the death rate in our country is currently among the lowest in the world at 1.8%.1 The global death rate is currently about 4.8%.1
It is important to keep in mind that these mortality percentages may actually turn out to be high as they are based on confirmed cases. The actual number of cases is possibly several times as many as the confirmed number thus potentially lowering the mortality percentage. In addition to the health impact and human cost, the coronavirus is causing a great deal of disruption in the global economy and financial markets. Fear has gripped consumers, government officials and business leaders. No one, not even the scientific community and medical experts, has much visibility on the potential health impact of the coronavirus. It is a scary time, and we all need to search for that silver lining in the current dark cloud.
In this letter, we will present three possible economic and market scenarios based on the information we have gathered thus far. We must humbly admit that our ability to make any economic and market forecasts is greatly hindered by the uncertainty of the future progression of the coronavirus. There are a wide range of estimates as to the eventual number of cases and deaths we will see in the U.S. and globally. Since we are not epidemiologist or medical experts, we will not give any opinion on the health impact of the coronavirus. However, we will make some assumptions in each of our three scenarios about the potential progression of the virus in the US in order to help us assess the potential economic and market impact.
Here’s what we know about the coronavirus. We know the virus is very infectious and spreads quickly and indiscriminately throughout communities once a number of cases has developed. We know from the Chinese and South Korean virus experience that “social distancing” reduces the spread of the virus. From China’s and South Korea’s experience with the virus, it appears that from the point from when 100 cases were reported to when the number of new cases diminishes significantly is about 6 to 8 weeks if measures are put in place to restrict social movement. We know there are currently no known vaccines to combat the virus. However, there currently exist, medical treatments as well as some promising existing drugs that can help treat the symptoms and reduce the severity of the illness.2 Below are three possible scenarios for the U.S. economy and financial markets as we see it. Of course, we understand that both the progression of the coronavirus and the potential economic impact changes almost daily and thus, our opinions may also change. We will start with our base case that we feel has the highest probability and then discuss a pessimistic and an optimistic case.
TCM Base Case
Our base case assumes the virus progression in the U.S. follows the pattern we have seen in other countries where the timeframe from the point when there were 100 coronavirus cases confirmed to the substantial reduction of new cases has been six to eight weeks. In this scenario, the U.S. is completing week four in its progression which leaves two to four weeks remaining before we may begin to see a substantial decline in the number of new cases. It was around March 2 when the number of coronavirus cases reached 100 in the U.S.1 If the eight-week timeframe holds for the U.S., that would put us close to the end of April before we see significant improvement in the progression and arrest of the virus in the U.S.
As of March 27, according to a recent article by Business Insider, 23 states and many more cities and counties in other states have issued stay-at-home orders.2 Business Insider estimates nearly 52% of the U.S. population is currently under some form of stay-at-home order.2 As the virus progresses, we believe more communities and states will issue such an order before the spread of the virus begins to recede.
Under this scenario, we believe economic growth will be significantly impacted in the 2nd quarter as the U.S economy slows dramatically. We concur with Fed Chairman Jay Powell that the economy may already be in a recession.3 In our view, the economy will show negative GDP growth in the 2nd quarter of this year as much of the country will essentially be locked down for at least part of the quarter. However, we see a recovery starting in the later part of the 2nd quarter and accelerating into the 3rd quarter as the virus spread recedes and the economy begins to open back up again. Our base case assumes that severity of the economic decline is mitigated by massive U.S. government stimulus and efforts by the Federal Reserve to stabilize the financial system. Congress recently passed a $2 trillion stimulus plan that will provide much needed cash to consumers, businesses and the medical community to help get through the crisis. In addition, we are making the assumption that most Americans will comply with the stay-at-home orders and adopt social distancing practices that have been recommended by the CDC. We believe these measures are vitally important in reducing the spread of the virus, shortening the economic damage, and preventing our healthcare system from getting overwhelmed.
We have already seen a significant impact of the coronavirus on the financial markets. Since February 19, when the major U.S. stock market averages reached all-time highs, stocks have been hit hard.4 At one point at the end of trading on Monday, March 23, the major stock averages had fallen about 35% on average from the February 19 highs.4 The major averages have since bounced off those lows. For the month of March, the S&P 500 Index recorded a decline of 12.5%.4 Year-to-date as of March 31, the S&P fell 20% in value.4 We expect market volatility will continue until there is more visibility on the progression of the coronavirus and its economic impact. We would not be surprised to see the major averages test the March 23rd lows when the S&P 500 hit 2191 and the Dow Jones Industrial Average (DJIA) hit 18,213.4 In this scenario, we believe those levels will hold based on both fundamental and technical factors.
Wherever the stock market bottoms out, we are confident that we will see a significant recovery over the following quarters. We base our confidence on our belief that the best scientific and medical minds will solve the coronavirus puzzle in the next several months and the virus will be substantially arrested by the end of this year. We believe it will take several quarters and possibly more than year for the economy to get back to where it was in 2019. However, in past recessions, we have observed that the stock market tends to bottom out and start its’ recovery at least 3 months before the end of a recession. Since we believe the recession will end sometime in the 3rd quarter of this year, we see the market bottoming out in the 2nd quarter. 3
The Pessimistic Case
We present a pessimistic case that we see as a very low probability but a possibility that should be considered by investors. This case is based on a prolonged progression of the coronavirus in the U.S. extending into the 3rd quarter and possibly the 4th quarter of this year forcing either the President to issue a mandatory stay-at home-order for all Americans or the majority of states issuing such an order which extends into the summer months. In this scenario, we see significant negative economic impact on the U.S. economy that leads to a deep, prolonged recession such as the ones we experienced in 1973-75 where GDP fell 3.2% peak to trough and unemployment hit 9% with a duration of a year and four months and the 2008-09 recession where GDP fell 5.1% and unemployment peaked at 10% with a duration of a year and six months.5 In the 1973-75 recession, the S&P 500 Index fell 48% from January 1973 to October 1974 and in the 2008-09 recession stocks fell 57% from October 2007 to March 2009.6 In this scenario, it is difficult to assess the maximum stock market decline or the eventual recovery. Again, we see the probability of such a scenario as very low at this time.
The Optimistic Case
In this scenario, the fears of the virus spread prove to be overdone and the economic impact, although negative in the short-term, is milder than expected by most economists. This scenario assumes the stay-athome period is short-lived and the government policy response proves to be more than adequate to mitigate the economic damage. In this scenario, we see a “V”-shaped recovery with no more than a one quarter of economic shock followed by a speedy recovery. In addition, the 35% decline in the stock market averages from February 19 to March 23 proves to be the extent of the bear market and stocks recover their losses by the end of 2020. We give this a higher probability than the pessimistic case but significantly less than our base case.
All of these scenarios are based on our opinions and are subject to change. These are for informational purposes only.
What you should do now…
First, take care of your health and your family’s heath by following the CDD recommendations on how to protect yourself per this link: https://www.cdc.gov/coronavirus/2019-ncov/prepare/prevention.html Second, reassess your risk tolerance and investment objectives. Examine your current portfolio asset allocation to make sure it is in line with your tolerance for volatility and long-term investment objectives. Third, if you are over 65 or retired, we recommend that you have at least two years of your annual spending budget in cash or short-term marketable securities depending on your situation. If you are under 65 and still working, have at least six months annual spending in cash reserves depending on your situation. Fourth, if you haven’t developed an investment action plan in light of the recent market volatility, do so now. Volatile markets can present tremendous investment opportunities. To best take advantage of the volatility, you should have a specific plan in place to help remove emotions from your investment decisions. In our experience, investment decisions largely based on emotions and short-term reactions to market movements usually end up being bad decisions. Fifth, stay calm. Regardless of what happens over the next few quarters, we are very confident that this difficult situation we find ourselves is transitory and we will get through it. We believe a year from now, we will have defeated the virus, the U.S. economy will be back to growing again and the stock market will be knocking on the door of all-time highs again.4
Here are four reasons for why we remain optimistic about our economy and the financial markets:
1. While the coronavirus is scary and difficult to predict in the short term, we feel strongly that by the end of the year, the global scientific and medical community will develop vaccines and other therapeutic treatments that will defeat this virus. There are already vaccines that have been developed that look very promising. We believe at least here in the U.S. the FDA will fast-track any vaccines that are shown to prevent and/or arrest the coronavirus.
2. We believe the U.S. federal government and Federal Reserve Bank will do whatever it takes to reduce the economic impact of the coronavirus. A couple of weeks ago, the Federal Reserve lowered interest rates on its Fed funds rate to near zero. In addition, they have injected hundreds of billions of dollars into the financial system to provide liquidity for banks and other financial institutions and set up measures to back stop the $3.8 trillion in prime money market funds. Most recently, the Fed launched an unprecedented effort to keep money flowing to companies, households and cities. As we mentioned earlier, Congress passed and the President signed a $2 trillion stimulus package. We are impressed with the speed and magnitude of all these measures to shore up our economy. It gives us confidence that the government will go to great lengths to support the American people as long as the effects of this virus remain.
3. The financial markets are working. Although we have seen an unprecedented level of market volatility over the past several weeks, the mechanics of the financial markets in the U.S. and around the world are functioning properly. While the markets are in the midst of repricing for this new and unexpected norm, while painful, that’s what markets do. The market circuit breakers as they are called, have been triggered a few times over the past few weeks to create a pause in trading in an effort to cushion market volatility. Some have suggesting closing the stock market until this crisis passes. However, such a move would undermine confidence in our markets and create even more volatility when they reopen. We believe it is highly unlikely that we would see an extended period where financial markets are closed for trading.
4. Lastly, our county has shown time and time again, its resilience in the face of a crisis. We have the economic and governmental systems in place to handle any crisis as well as the ability to adapt to our new reality. We are already innovating our way out of this crisis. Schools and businesses are finding ways to keep learning and commerce moving forward through electronic resources that we can utilize in our homes. Automakers and medical equipment manufacturers are retooling to meet the demand for ventilators. Pharmaceutical companies are working around the clock on therapeutic solutions and new vaccines. Various makers of things like hospital gowns and masks are ramping up production to meet the current shortages and future need. All across our county, the private system is adapting and mobilizing to help deal with the crisis. Regardless of how difficult this crisis becomes over the next few months, we are optimistic we will defeat the virus and get our county back to work and back to normal again.
In the meantime, the Trinity Capital team is working on your behalf to manage through this crisis. Our office remains open despite a stay-at-home order by Smith County. Our business falls into two exemption categories that allow us to stay open. However, we are abiding by the CDC guidelines for social distancing to keep our team safe. If we need to work from our homes we have the necessary equipment and capability to fully handle all administrative tasks and portfolio management functions.
If you have any questions or concerns or just need a need a little reassurance, we encourage you to call or email us. We value our relationship very much and greatly appreciate the trust and confidence you have placed in us. We will continue to closely monitor your portfolios and keep you updated on the financial markets. Stay safe and God bless you.
3 Wall Street Journal, Powell Says Economy May Be in Recession, Virus Will Dictate Timetable, March 26, 2020
4 Thompson Charts
6 Wells Fargo Investment Institute, Asset Allocation Spotlight, March 17, 2020
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