When Will We Get Back to Normal

The longest bull market in history had been on virtual cruise control since 2009. In March it gave way to the fastest bear market crash in history. Market volatility returned with a vengeance as investors seek to gauge the depth and duration of COVID-19’s impact to the economy. Consumers and small businesses are facing a cash crunch. In the past month the US lost 22 million jobs. That’s the total of jobs gained over the past 10 years. The question is when we can resume normal living and economic activity.

Three primary cases are being put forth. Each carries different risk for your money.

Case 1: V-Shape Recovery – back to normal soon
This was a healthcare driven recession. There was nothing inherently wrong with the economy before COVID-19. Unprecedented fiscal and monetary relief will buy time, we’ll mitigate the virus, and we can get back to work. Pent up demand will bring a quick economic recovery. This case looks very unlikely.

Case 2: L-Shape Recovery – Rising Prices (Inflation); normal won’t be soon
The economy had been running on too much low-cost debt. The coronavirus was the catalyst, not the cause of the recession. Unprecedented fiscal and monetary relief will buy time, but will it be enough to meet the need. Unlike 2008-09, it’s not just banks or one industry that are in trouble; small and large businesses across the country are closing and piling up debt. Some combination of large deficits and large tax increases will be needed. Inflation will rise. Social unrest between haves and have nots could likely ensue. The road back to normal will take time. What if we don’t get the virus under control?
• Assets likely to best perform: real estate, stocks, gold, commodities

Case 3: L-Shape Recovery – Falling Prices (Deflation); normal won’t be soon
Aren’t declining prices good? Not if they are sustained and result in changed expectations. Meaning if consumers (70% of the US economy), decide to delay purchases with the expectation of that prices will keep going down. Growth will stagnate. There isn’t a way to stimulate demand. In many ways like Case 2, except it assumes there will be strong, unrelenting demand for US Treasuries which will drive rates lower, maybe even negative like in Europe and Japan. Why would anyone own a negative yielding bond? If prices are going down 2%, and your bond is -1%, you are still ahead of the game. It’s bad for debtors (if the value of your house goes down, the mortgage doesn’t).
• Assets likely to best perform: cash and bonds

We can’t be sure how the future will play out. And in any of these cases it won’t be in a straight, predictable line. Diversified portfolios help to mitigate these uncertainties. It’s not a perfect solution, yet it lets us balance the risks in each asset class through market cycles. Periodic re-balancing imposes a buy low, sell high discipline, so we can keep your money consistent with your need, your comfort level, and your capacity for risk.

Signals and Things to Monitor

• 4/14 – JP Morgan and Wells Fargo increased reserves for loan losses substantially higher than forecast; the dollar amount implies defaults by consumers and businesses will be much higher than 2008-09.
• 4/15 – Retail sales declined 8.7%; industrial production and manufacturing fell by the most since 1946.
• 4/16 – Unemployment: as of this date we’ve lost 22 million jobs.
• The oil price war puts further downward pressure on prices. Russia and Saudi Arabia are unpredictable, and their game of chicken has already brought havoc to US shale producers which could further increase unemployment.
• Supply chain disruptions as businesses go under combined with rising protectionist and nationalist tendencies. If hyperbolic politics continues to cloud reasoned analysis and compromise, it will be bad for systemic efficiency.
• Lack of global leadership to coordinate pandemic, fiscal, and monetary policies.

Asset Class Review

US large stocks held up better on a relative basis. Small and mid-cap stocks typically decline more in a recessionary environment. That was the case in Q1 2020.

International stock markets were roughly in line with the US markets.

The hospitality and retail sectors of the REIT market were especially hard hit due to travel restrictions and store shutdowns. REITS rely on lease rental payments, equity, and debt financing. Investors own them for dividend paying capacity. Fearing dividend cuts or suspensions, sellers were out in full force.

In the commodities complex, oil fueled the declines falling 70% from $66 a barrel in January to $20 at quarter end as Saudi Arabia and Russia decided to increase supply even as a demand weakened. Copper declined 25% from its peak. Gold was a place of refuge, ending the quarter up about 7%.

The bond market provided stability – mostly. The Federal Reserve’s intervention helped to calm the market in late March when liquidity started to dry up and it looked like the bond market might seize up. US Treasuries were the best performing sector in the bond market as investors fled to low risk, high quality assets.  

 

 

PLEASE NOTE: You can’t invest directly in an index. Past performance does not guarantee future performance. All investments are subject to risk, including possible loss of the money you invest. Diversification does not guarantee profit or protect against a loss. Nothing herein or elsewhere on this site constitutes investment, legal, or tax advice. For details please see Disclosure.