There may well be some correlation between the use of sports analogies and the turning of a psychological corner for the financial markets. Perhaps it was the imminent passage of a huge stimulus package designed to limit economic damage caused by the coronavirus. Whatever the cause, we have seen some stabilization and optimism appear in the markets over the last couple of days.
What began as a health crisis quickly escalated to a major financial catastrophe as all 50 states declared a state of emergency and an estimated 80 million American workers are effectively on lockdown. In our lifetime, we have no equivalent event to which this compares and clearly fear and wild conjecture overtook the financial markets in the absence of solid data. The S&P 500 fell 33% from a record high on February 19, a period of just 23 trading days. To put this in perspective, the transition from bull market to bear typically takes around 10 months.
In terms of the economy, we know the most ominous news is yet to come as the impact of virus translates into the economic data points on which so many of us rely. We know the virus numbers will continue to increase for some period of time, unemployment claims will balloon as many businesses temporarily cease operations, and earnings announcements and guidance will be atrocious as they start to reflect our current reality. We got our first glimpse of this as 3.28 million people filed for unemployment claims in the week ended March 21. Likely these headlines will continue to test the resolve of investors.
Although we have no proxy for this environment, we did learn some things in the Great Recession of 2007/2008. Many of the monetary tools employed successfully during that time have been quickly resurrected. The rapid crisis response from the Federal Reserve and the federal government has been robust and unprecedented, throwing everything but the kitchen sink at this problem. A list of the major components of the Federal Reserve initiatives is included below.
The fiscal response requires more bipartisan cooperation and the response has taken a bit more time, but this week the House and Senate reached agreement on a massive $2 trillion rescue package. The bill has passed in the Senate and is expected to be voted on by the House on Friday. This legislation will backstop the economy and unemployment in a variety of different ways. Major components of the bill include:
- $500 billion in direct assistance to individuals with checks to qualifying households, enhanced unemployment support including four months of coverage increased weekly benefit payments
- $367 billion in emergency assistance to small businesses including loans, grants, and a fund to cover up to 6 months of payments for existing Small Business Administration (SBA) loans
- $100 billion in assistance to employers in the form employee retention tax credits and interest deductions
- $425 billion in treasury funds for corporate loans, purchase of municipal and corporate securities, and secondary mortgage market
- Targeted assistance in the form of $150 billion is allocated to state and local governments, $100 billion in assistance to the health care system, $30 billion in emergency educations, and $25 billion in emergency transit funding
- A component targeted to stabilizing key industries, including airlines, air cargo, and national defense to prevent layoffs. This program is similar to the Troubled Asset Relief Program (TARP) that we recall from 2008.
Worldwide we have seen announcements of both fiscal and monetary stimulus packages, including lowered interest rates, relaxed capital requirements for banks, and other efforts targeted to businesses and individuals impacted by this global pandemic. Additionally, in a statement from the Group of Seven (G-7), world leaders and central bankers vowed that they will do “whatever is necessary” to restore confidence and economic growth and to protect jobs, businesses, and the resilience of the financial system. A list of the specific global initiatives is included below.
We can look to China for a clue as to how this may play out. Chinese manufacturing suffered absolute paralysis as reflected by the Purchasing Manufacturers Index, a measure of activity, which fell to 35.7, the fastest decline on record. Anything below 50 reflects a contraction. At this point in the crisis, which first began there in December, new cases of the virus have slowed to a trickle. Businesses, factories, and life is slowly and cautiously returning to normal – the “new normal.” We will have indications in the coming weeks if the response in the United States, and the dramatic efforts to curtail the spread of the virus, will result in an outcome that is more favorable than in some other countries that reacted less quickly and decisively.
It is hard to believe that it was just a few short weeks ago that I was preparing for a Boys & Girls Club gala, plotting my March Madness bracket revenge, and making travel plans for my youngest daughter’s college graduation. While we have no comparable economic event, I can certainly remember days when I was sure that things would never again be the same — September 11, 2001 is a great example. Slowly but surely, things do return to something like normal. Personally I believe in the spirit, fight, and resilience of the American people. Yes, we are going to hear more negative news and we know that earnings and economic data in the coming months will be frightful. At this point, the market has factored in a massive and extended period of economic decline in the United States. Throughout this, our message to clients has consistently been to look to the past and other significant market disruptions and subsequent recoveries, many of which I have personally experienced in my 36-year investment career. Although nothing has before been just exactly like this, the U.S. and the world have faced many crises over the years, both financial and humanitarian. People will prevail, business will prevail, and science will prevail!
Federal Reserve initiatives:
- Made an unscheduled 50 basis point (0.5%) cut to the federal funds rate. (March 3)
- Injected $1.5 trillion into the financial system to allow banks to have more funds on hand through reverse repurchase operations. (March 12)
- Dropped the fed funds rate back to the 2015 level of 0% to .25. (March 15)
- Federal Reserve announced purchase of $500 billion in treasury and $200 billion in mortgage-backed securities. This “quantitate easing” program should be very familiar from 2008. (March 15)
- Added $500 billion to the reverse repo initiated on March 12. (March 16)
- The Federal Reserve lends money to its member banks on a short-term basis through the “Discount Window.” To support the liquidity and stability of the banking system, the Fed lowered the rate and provided access to funds for more extended periods of up to 90 days. (March 16)
- Rebooted another program used in 2008, the Commercial Paper Funding Facility, to allow the Fed to purchase commercial paper, short-term, unsecured loans made by businesses for everyday expenses. (March 17)
- Re-established a Primary Dealer Credit Facility to provide overnight loans to primary dealers to ensure smooth market functioning. This facility was used successfully during the 2008 financial crisis. (March 17)
- Created Money Market Mutual Fund Liquidity Facility to support the flow of credit to households and businesses. The key purpose of this program is to provide liquidity for money market funds that will likely see heavy outflows from large corporate and institutional depositors. This is a similar program to one utilized during the 2008 crisis. (March 18)
Other components of the federal response passed and implemented prior to today include:
- An initial $8.3 billion spending bill to fund vaccine research, support state and local governments, and some assist with efforts overseas to curb the spread. (March 6)
- A state of emergency was announced, allowing distribution of up to $50 billion in aid to states and cities. (March 13)
- Announced 90-day extension of income tax payments whereby individuals can delay up to $1 million in payments and corporations up to $10 million until July 15. (March 17)
- Phase Two of the stimulus bill (passed by the House on March 13) that highlights free virus testing, expanded unemployment benefits, additional support for Medicaid, and paid sick leave for workers impacted by COVID-19. (March 18)
International fiscal and monetary policy initiatives announced to date:
- European Central Bank offers overnight credit to banks at 0.25%, announced $128 billion in bond purchases and other programs similar to the U.S. to support financial markets, and created the Pandemic Emergency Purchase Programme with a price tag of $800 billion.
- Germany authorized its state bank to lend up to $610 billion to companies.
- France announced a $49 billion aid package that included social security tax cuts, expanded unemployment benefits, and a fund for shopkeepers and self-employed persons.
- Italy, which has been particularly hard hit by COVID-19, announced a $28 billion package including loan guarantees for mid and small businesses, money to hard-hit industries, and direct aid to displaced workers.
- United Kingdom has announced a number of successively larger stimulus packages. At this date they include a central bank interest rate of 0.15%, $379 billion in business loan guarantees, and $23 billion in business tax cuts and grant funding to businesses most impacted.
- Japan has passed $20 billion in targeted spending, $112 billion in quantitative easing, and 0% loans to businesses impacted by the virus.
- Our neighbors in Canada lowered their interest rate to 0.75% and $7.1 billion in loans to businesses.
- Australia: $11.4 billion in stimulus targeted at small businesses, individuals collecting government benefits, and business subsidies to those in hard-hit sectors of the economy.
- China has yet to implement any fiscal stimulus programs. On the monetary policy front, it has expanded reverse repo operations by $250 billion, cut the one-year and five-year prime lending facility rate to 4.05% and 4.75% respectively, and lowered bank reserve requirements.
- Hong Kong will provide fiscal stimulus including a $1,200 cash subsidy to all adult permanent residents, one month of rent for those in government housing, and cuts in payroll, real estate, property, and business taxes.
- South Korea rolled out a $9.8 billion fiscal package including child care subsidies.
March 26, 2020
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Market Volatility Webinar
We recognize that this is an anxious and troubling time, both for individuals concerned about health risks as well as for our investor clients experiencing ongoing market volatility.
Our personal connections with our clients mean everything to us, so as an alternative to reaching you silently through email, we worked quickly to produce this webinar with our latest Market Update. We truly hope you find it valuable.
Investing is very personal, and while we can address a multitude of general questions in this format, I encourage you to reach out personally to me and our team with your specific concerns.
Thank you, and please know that we are here for you in this unsettling time.
First Business Trust & Investments
March 19, 2020
Market Update – March 17, 2020
One thing investment professionals hate to say is, “We don’t know.” Clients look to us for answers and solutions and that is a role that we cherish. Earlier today, I saw a quote from economist John Kenneth Galbraith, who said, “There are two types of economists, those that don’t know and those who do not know that they don’t know.” So it is a painful thing to be in this situation where markets and the economy are fluid and unpredictable, not behaving in a rational or forward-looking manner, but we will continue to communicate to you our best thinking and our outlook for the future.
The situation as of today, Tuesday, March 17, is that there was a cascade of preventative measures put in place to contain and slow the spread of coronavirus in the United States. Clearly the economic impact of this lost productivity will be significant in the short-run with a large swath of the U.S. economy essentially shut down for an uncertain duration. Most economists are predicting negative economic activity in the first two quarters of this year, which would bring an end to this historically long expansion. Most also predict a strong finish to the year as normal activity resumes. Whether it will be a “V” shaped recovery or more of a “U” is subject to debate. I have yet to hear a plausible scenario where the U.S. economy fails to recover from this historic event.
On Sunday, the Federal Reserve announced that it was cutting the short-term target a full percentage point to between 0% and 0.25%. With this cut, the Fed comes full circle back to where we were in December 2015, when it began the process of moving the federal funds rate higher, joining the European Central Bank and the Bank of Japan whose policy rates are also at zero. The Fed also cut the rate on direct loans from its discount window to banks by 1.5%, and extended the term to up to 90 days, to help banks “meet demands for credit from households and businesses.” The Fed, as the supervising authority of the banking industry, is also encouraging banks to lend more without worrying about their capital buffers. In addition, the Federal Reserve will buy hundreds of billions in government debt. The purpose of these moves is to help ensure that a liquidity crisis does not become a solvency issue.
In addition to the monetary policy assistance, there are several fiscal responses either in the works or under consideration. Most are targeted to ease the burden on companies and individuals who are adversely impacted. Expect more to come in terms of both governmental and private sector responses.
After a historic 131 months, the bull market is officially over. Equity markets in the U.S. are down more than 26% year-to-date. The stock market is a forward-looking indicator, reacting very quickly to economic changes, both on the upside and the downside. Some investors will ultimately decide that they do not have either the time horizon or intestinal fortitude for the equity markets. Others theorize that it is possible to miss market volatility, consistently getting out before a decline and stepping smoothly back in at the bottom. Unfortunately, this type of market timing is very difficult to successfully execute. One thing we know with certainty: every bear market in history has led to new all-time highs at some point in the future. There is no reason to believe that this time will be any different. Since 1928, we have had 24 bear markets. The average “break even” time following a bear market has been just over two years. In the more modern era, that has been shortened, with market declines since 1950 fully recovered on average in 16 months.
We have made some modifications to our investment approach based on opportunities presented by the current investment environment. In fall of 2019, we established a position in a minimum volatility fund in our domestic equity portfolios. Today we are expanding our minimum volatility exposure into the international equity space by reducing our MSCI EAFE ETF by half and investing in a MSCI EAFE minimum volatility alternative. Through this trade, we are maintaining our exposures, realizing available losses, and better positioning our portfolios for the long run.
In many respects we are entering this downturn in much better financial condition than in 2007. Unemployment is very low, banks are better capitalized, and consumer and corporate balance sheets are in a much stronger position.
Sailors will tell those who suffer from seasickness to focus on the horizon to minimize nausea. Throughout this period of volatility, we have maintained the position that long-term investors need to focus on the horizon, as well.
Please be assured that our team will remain accessible during this time to discuss your specific situation and help you through these unprecedented times. Thank you.