So Now What?
There is optimism and evidence based on WHO and CDC numbers that the spread of COVID-19 has started to decelerate in the United States and Europe, in particular the NYC metro area. The battle against this virus has often been compared to fighting a war. War is a good analogy, but we think a terror attack might be a better analogy. Perhaps we are splitting hairs between two awful events, but wars tend to be longer, more drawn out, and somewhat anticipated while terror attacks are immediate, arrive without warning, and are over quickly. Like this virus, the physical toll of a terror attack isn't prolonged. It’s the fear that lingers on that can be a destabilizing force within a society. We don’t yet know to what extent that will be true with this attack. Nevertheless, given our nation's much larger experience with wars, we will stick with the war analogy. During the major World Wars, our sole focus was on defeating the enemy. If the enemy was not defeated, nothing else mattered. The same is true with COVID-19. It was not until the World Wars were approaching their inevitable conclusions that world leaders started to think about what’s next. The Treaty of Versailles (Paris Agreement) is a stark reminder of the consequences of being short-sighted, while the Marshall Plan is a good example of the benefits of thinking and planning for the longer-term. Just like WWI and WWII, despite this war’s end appearing inevitable, it will take a long time for this enemy to officially surrender. Our leaders are starting to discuss what’s next. On Tuesday, Governor Cuomo used the last part of his press conference to briefly introduce the topic of what’s next. It’s the first time the Governor has allowed himself to mention anything other than social distancing, ventilators, ICU beds, etc. His sole focus has rightfully been on defeating the virus that is terrorizing New York. If the Governor of New York is starting to entertain thoughts of reopening business, you can be assured the Governors of less impacted states are well ahead of him. In our last commentary, we said that in the immediate term stock markets would react to the direction of the virus, not to economic numbers. The virus appears to be winding down faster than anticipated, which means economic activity will pick up sooner than anticipated. Stock markets have responded as we would expect. Before planning what’s next, let’s first do a damage assessment. The S&P 500 fell 33.9% from its February 19th high to its March 23rd low. As of last night, stocks have bounced 23% from that low. The S&P 500 is currently -13% for 2020.
Non-Investment Grade Corporate Bond yield spreads (aka, High Yield and Junk Bonds) widened from their tightest levels of 350bps (basis points) over treasuries to 1100bps over treasuries. Spreads have since tightened to 769bps.
Investment-grade bonds yield spreads have also widened from their tightest levels of -25bps below treasuries to 190bps over treasuries. Spreads have since tightened to 87bps over treasuries. We believe corporate bond yield spreads are a very important indicator to watch going forward, more on that below.
Interest Rates have dropped across the entire yield curve and are now at record lows. Short rates are near zero and the 10-Year yield remains below 1%. At their lowest yield, short-term rates (Fed Funds Rate) were slightly negative and the 10-year yield dropped to 48bps. Both are now higher.
Looking forward – The Trump Administration and Congress are passing what they refer to as stimulus packages. We don’t mean to nitpick but these are not stimulus packages, they are packages designed to float (provide cash flow to) the economy until economic activity resumes. The distinct difference is that stimulus is designed to create consumer demand in discretionary spending, which then boosts economic growth through the creation of additional supply to meet the additional demand. When the economy is shut down, insufficient supply is not the issue (with the perplexing exception of toilet paper). The issue is not discretionary spending but non-discretionary spending. Paying for shelter, food, electricity, etc. becomes the issue for many people that find themselves suddenly unemployed. The goal of these “stimulus” packages is not to entice the consumer to buy a new television set or eat out more often. It is to make sure they can pay their mortgage and electric bill. This in turn allows the bank and the electric companies to service their corporate debt until the economy is turned back on. As we learned the hard way in 2008-2009, if credit markets collapse so does our economy. Therefore, we believe key indicators to watch are corporate bond yield spreads. Yield spreads show the risk associated with a company defaulting on its debt payments. The wider the spread, the higher the expectation of default. We are watching this indicator very closely. As of now, spreads levels are telling us that the fear of corporations defaulting on their debts has lessened. The stimulus packages appear to be accomplishing their intended goals of providing cash flow (floating) the economy while we are shut down. If parts of the economy don’t start reopening soon, this will change quickly. Our expectation continues to be for a V-shaped initial bounce in stocks, which we may have already seen, followed by a slower and volatile grind higher. We don’t expect markets to recapture their all-time highs in 2020 we but think it is possible in 2021. In the near-term, markets will move in the opposite direction of the virus. As economic numbers begin to stabilize, we will have a much better idea of what a fair value price for stocks should be. Our frameworks continue to recommend adding risk to the portfolios. We have decided not to do so. We will almost certainly experience very volatile markets in the near-term. Stock markets may revisit prior lows, or the worst may have been over on March 23rd. We can’t say with any degree of confidence what the next several weeks will hold. We continue to be confident that stock markets will be higher a year from now. Our top priority is making sure everyone sticks to their longer-term investment plan. Adding risk is not consistent with this goal. We mentioned in our last letter the importance of staying connected during this period. With all the focus on defeating this virus, it’s easy to overlook the mental and emotional toll this virus is having. We continue to be available for both financial and non-financial conversations. Call of the Wild - We enjoyed this box office flop more than we expected to. Admittedly, this is a movie we never would have bothered watching in a world with other options. The screenplay stays relatively true to Jack London's 1903 novel, with some noticeable changes to reflect society's current sensitivities while also making the movie less traumatizing for children. More specifically, they don't shoot any dogs in this version. The movie uses CGI (computer-generated images) for Buck the Saint Bernard. While the technology is a bit awkward at times, it allows for scenes that otherwise would not be possible for even the most well-trained dog. This is a solid family movie that will challenge you not to shed a couple of tears but will also leave you with a smile. Call us anytime about anything, The GreenPort Team