FSC Wealth Client Quarterly Letter First Quarter, 2020
This is normally the time of year when we start our quarterly letter noting the beautiful warmer weather, the budding flowers and trees and how nice it is to see our neighbors out walking around the neighborhood enjoying the better climate. Unfortunately, that is not the case this year. In the Northeast, we are getting that warmer climate but we are under a mandatory lockdown and social distancing is a way of life, at least for the near term. Families that are out & about enjoying this time of year can usually be seen walking down the sidewalk enjoying themselves albeit wearing a mask. Then there is the inextricable fear that comes over their faces when another family or individual approaches them. You can almost see the situation play out in their minds, they ask themselves questions like “Should I cross the street?” “Do I have enough space to pass safely?” “Are they going to cross?” as you know, there is an overarching fear surrounding the global pandemic and “Social Distancing” is a way of life at the moment. These kinds of anxieties play out in markets as well.
The world is in flux because of COVID-19, the disease caused by the novel coronavirus. Yet we are confident that the American people will face this adversity with a renewed sense of confidence, selflessness, and determination. Before we outline our approach for investing amidst these unprecedented circumstances we first must express our sincere gratitude to all of those health care workers and first responders on the front lines battling this disease, and to the unsung heroes keeping our essential businesses up and running. We have no doubt that we will make it out of this calamity stronger than ever thanks in large part to these brave men and women.
Black Swan → Uncertainty → Volatility
The stock market’s behavior the past month is easily explained but difficult to surmise. COVID-19’s arrival and spread followed by the subsequent state-by-state shutdowns caused investors to reassess stock values based on the inevitable upcoming hit to earnings. Add in the knock-on effects of a likely recession and the discounts on stocks make perfect sense.
Market participants are trying to find a new level reflective of the current reality. To that end, this past month’s violent whiplash volatility becomes the new normal until a new equilibrium is found. The trendless, yo-yo trading we see is based on reactive emotion, giving no clear indication of the direction the market is heading in the near-term. This is the definition of a trendless market.
Above, you can see the first quarter returns for the major indexes along with the long-term treasuries ETF - $TLT. What is truly unique about the market’s recent behavior has been the magnitude and speed of its moves. The lurching daily convulsions that followed the justified re-pricing indicate that emotion is dictating much of the heavy trading. Trader sentiment turns from ecstatic to despondent from one day to the next with record-setting buying offset by similarly record-setting selling. Stocks entered a bear market at their fastest pace ever. The S&P 500 hit an all-time high on February 19; it fell -26% from this high less than a month later on March 12. Not only did the S&P set a bear market speed record, it also set a record for speed with which it fell over -30% (only 22 trade days). Not to be outdone, the Dow Jones Industrial Average also set records based on the magnitude and speed of its moves in March. The Dow fell into a bear market in just 19 trade days.
Daily volatility in March was extraordinary. March was the S&P 500’s most volatile month in its history. The average daily percent move for the S&P in either direction for March was 4.9%. For perspective, the average daily moves in October 1929 (the Great Crash) and October 2008 (Financial Crisis) were a full percent less at 3.9%. For the first time in its history, the S&P rose or fell at least 1% on 21 trade days in one month. We are living through momentous market history.
As you can see on the table to the right, outside of the initial drop, there is no clearly-discernable pattern to the market’s erratic movement. Such volatile trading tends to be emotional noise. It is indicative of nothing more than fear and pervasive uncertainty. Volatility begets volatility so we can expect more erratic trading in the days ahead.
While the COVID-19 black swan and its economic consequences are new, volatile market behavior is entirely familiar. A volatile market demands a rational, dispassionate response. Given the extremely heightened volatility, many of our portfolios have signaled into defensive stances. We are, in effect, keeping our powder dry while the storm rages. This provides opportunity because it allows us to observe the market day-to-day and, with the help of our quantitative portfolio software, exposes new opportunities as they may arise.
After all, we know that the chaos of a temperamental market is temporary. In the thick of it—when 2% or 4% daily moves seem routine—the calm markets we rarely appreciated before the arrival of the black swan seem like distant memories. Remember that their return is inevitable. Also, we cannot overstate the importance of avoiding the market’s worst days. Avoiding historic drawdowns preserves capital that can be reinvested when volatility finally wanes.
This crucial market lesson dovetails with our investment strategies that are applicable to all markets. Be they peaceful or turbulent, our counsel is the same: intelligent, unemotional allocations to rising asset classes and rational defensive positioning when necessary. This approach informs both our tactical portfolios and our strategic portfolios.
Our tactical portfolios analyze asset price movement every day looking either for opportunities to engage or appropriate timing to go on the defense. Because these tactical portfolios contain multiple sleeves and perform their analysis daily they are able to maintain a certain amount of participation and react quickly in response to identified trends. Our strategic allocation portfolios use a process to allocate assets to a diverse group of carefully-selected funds. These unique allocations are arrived at in order to achieve a certain amount of desired movement as compared to a benchmark index. Strategic Asset Allocation portfolios are re-analyzed once a month using a value calculation. In this way, then, our strategic portfolios can sustain market participation, react to long-term trends, and conserve capital by reducing overall portfolio volatility.
Unprecedented Response to Stabilize Economy and Combat Virus
While this pandemic crisis is unprecedented, so, too, are the responses we have seen in concerted efforts to both stabilize the economy and eliminate government regulation in order to fast-track treatments for COVID-19. The federal government came together in recognition of the severity of the situation to design and pass a massive $2 trillion relief package: the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). Treasury Secretary Steven Mnuchin worked closely with Congress to ensure aid to nearly all Americans. The CARES Act, the largest economic stimulus ever, does the following to help Americans ride out the shutdown:
Preliminary economic data gives us the first glimpses into what lies ahead in the second quarter. For the first time in ten years we saw a net monthly loss of jobs in March. The unemployment rate shot up from 3.5% to 4.4%. We can only speculate where unemployment might end up for April, as most states have issued stay-at-home orders and have closed non-essential businesses. Both Goldman Sachs and Morgan Stanley predict unemployment to peak at 15% this year. Analysts forecast a historic drop in GDP growth as well: for the second quarter estimates range from -10% to -34%. A recession—defined as two consecutive quarters of contraction—seems likely.
That being said, the best way out is always through. We will fight our way through this crisis because we entered it from a position of strength. Our economy was firing on all cylinders with record low unemployment, with steadily rising wages for lower income Americans, and with
ongoing deregulation to help businesses succeed without having to battle the bureaucracy. Our economy is experiencing a voluntary intermission in order to save the lives of our most vulnerable. A recent paper from researchers at the Massachusetts Institute of Technology and the Federal Reserve analyzed data from the Spanish Flu pandemic of 1918 and found that local governments that took earlier and more aggressive steps to stop the spread of the outbreak resulted in better economic performance
after the pandemic subsided. Given the breadth of the current stay-at-home recommendations, the strength of our economy going into this crisis, and the fact that our government and central bank appreciate and are addressing the strain this is causing to the economy, we believe the vigorous American economy is primed to kick back into action once the threat of this Coronavirus is eliminated notwithstanding any recession.
As Joe Weisenthal of Bloomberg states, “the virus is stress testing the entire socio-economic and political system all at once.” We are writing this newsletter in the midst of what President Trump says will be a “hell of a bad two weeks.” Nevertheless we believe our socio-economic and political systems are acing this stress test so far. Markets are functioning, stocks and bonds are being bought and sold and investors are still flocking to that safest asset in the world: U.S. Treasury Bonds. We will remain, as Queen Elizabeth implores, united and resolute. We have no illusions about the difficulties we will face but we have the utmost confidence that the resilient American people and the economy that they have made the most dynamic in history will pull through this in the end, and sooner rather than later.
As planners we understand that the straight lines of our financial plans will in reality be bent this way and that by the bull and bear markets of the future. While times like these are unsettling to say the least, our projections and advice have included provisions for these sorts of events. If you have questions about your overall planning or portfolio, we’d be delighted to hear from you.
At FSC Wealth advisors, it is our fiduciary responsibility to help you make decisions that are in your best interest. That being said, Planning is the key! We need to make sure that we are aware of any changes in your personal situation and financial condition. It is important that we discuss any changes during our regular meetings, but you don’t have to wait for those meetings, please feel free to call our office at any time to discuss your situation.
Sooner or later we’ll be through this situation. Until then we have lots of work to do, helping those less fortunate and supporting our health officials in putting an end to this pandemic.
We appreciate your trust and confidence in us and we remain,
The FSC Wealth Advisors Team
Fall down seven times, stand up eight
– Japanese proverb
SECURITIES OFFERED THROUGH NEXT FINANCIAL GROUP, INC. MEMBER FINRA/SIPC. INVESTMENT ADVISORY SERVICES OFFERED THROUGH FSC WEALTH ADVISORS REGISTERED WITH THE SECURITIES AND EXCHANGE COMISSION. BRANCH OFFICE ADDRESS: 766 SGT. PALMATEER WAY, WAPPINGERS FALLS, NY 12590. FACULTY SERVICES CORPORATION & FSC WEALTH ADVISORS ARE NOT AFFILIATES OF NEXT FINANCIAL GROUP, INC. REGISTRATION BY AN ADVISOR DOES NOT IMPLY ANY LEVEL OF SKILL OR TRAINING.
No investment strategy or methodology can guarantee profits or protect against losses. Investment risk includes the uncertainty and volatility of potential returns for a portfolio or an individual investment over time. Investment risk is inherent in every individual portfolio and no computer model or modeling program used or relied upon in making investment choices for a portfolio can eliminate risk. A computer modeling program may not reflect actual risk and return parameters applicable to any particular portfolio or investor. Actual investment decisions made on the basis of a computer generated model or modeling program may be materially different from expected or intended results, and any computer modeling program is subject to errors in the program and system failures at any time.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is not a guarantee of future results.
The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.
The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
This report is for informational purposes only and is not a solicitation, or recommendation that any particular investor should purchase or sell any particular security. Information contained herein is obtained from sources believed to be reliable but its accuracy and completeness is not guaranteed. It is not intended to provide specific legal, investment, accounting, tax, or other professional advice. Individuals should consult with the appropriate professionals for their specific situations or needs prior to taking any action based on this information. Neither NEXT Financial Group, Inc. nor its Representatives give tax or legal advice.
- https://www.bea.gov (GDP data)
- https://www.bls.gov (employment data)
- https://www.federalreserve.gov (facilities information)
- https://www.finance.yahoo.com (index returns)
- https://fred.stlouisfed.org (GDP, employment data)
- Coronavirus (COVID-19) Update: FDA Continues to Accelerate Development of Novel Therapies for COVID-19, U.S. Food & Drug Administration, March 31, 2020 (press release).
- NIH clinical trial of remdesivir to treat COVID-19 begins, National Inst. of Health, Feb. 25, 2020 (press release).
- The Real Cure for Coronavirus, Wall St. J., March 30, 2020, at A18.
- Michael Cembalest, Eye on the Market, JPMorgan Asset Management, April 6, 2020 (on file with author).
- Emily Cochrane and Nicholas Frandos, Senate Approves $2 Trillion Stimulus After Bipartisan Deal, N.Y.Times, March 26, 2020, at A1.
- Sergio Correia, Stephan Luck, and Emil Verner, Pandemics Depress the Economy, Public Health Interventions Do Not: Evidence from the 1918 Flu, March 30, 2020, Available at SSRN: https://ssrn.com/abstract=3561560.
- Jeff Cox, Goldman sees 15% jobless rate and 34% GDP decline, followed by fastest recovery in history, CNBC, March 31, 2020, https://cnb.cx/3aRCVsD.
- Queen Elizabeth, Address to Great Britain, April 5, 2020, https://bit.ly/2V5NnGe.
- Scott Gottlieb, Bet Big on Treatments for Coronavirus, Wall St. J., April 5, 2020, at A19.
- Greg Ip, How to Avoid Another Great Recession, Wall St. J., March 31, 2020, at A2.
- Nicholas Jasinski, The Run Is On: Dow Industrials Returned to a Bull Market Today, Barron’s, March 26, 2020, https://bit.ly/2Xfs4oe.
- Peter Loftus, Drugmaker Moderna Delivers First Experimental Coronavirus Vaccine for Human Testing, Wall St. J., Feb. 24, 2020, https://on.wsj.com/2wlgEnW.
- Rich Miller and Reade Pickert, Top Economists See Echoes of Depression in U.S. Sudden Stop, Bloomberg, March 22, 2020, https://bloom.bg/2JP2nmO.
- Howard Silverblatt, Market Attributes: U.S. Equities March 2020, S&P Dow Jones Indices, April 3, 2020 (on file with author).
- Donald J. Trump, Remarks by President Trump, Vice President Pence, and Members of the Coronavirus Task Force in Press Briefing, March 19, 2020.
- Donald J. Trump, Remarkets by President Trump, Vice President Pence, and Members of the Coronavirus Task Force in Press Briefing, April 1, 2020.
- Tommy Reggiori Wilkes and Sujata Rao, U.S. economy to shrink at fastest rate since 1946, unemployment to top 15%: Morgan Stanley, Reuters, April 3, 2020, https://reut.rs/39Oq9da.
- Joseph Walker, Peter Loftus, and Jared S. Hopkins, Scientists Rush to Find Coronavirus Cure—but It Still Isn’t Fast Enough, Wall St. J., April 6, 2020, https://on.wsj.com/3e5X14f.
- Joe Weisenthal, 5 Things to Start Your Day, Bloomberg, March 20, 2020 (on file with author).