It goes without saying that the economic and market fallout associated with the COVID-19 outbreak is unsettling. Equity markets have rapidly declined into the fastest bear market outside of the Crash of October 1987, which happened in one day. It is hard to believe that we won’t see a recession in the first half of the year. Unlike past virus outbreaks and pandemics, in this country and globally, we have all but shut down to limit the spread of the virus. But like the outbreaks and pandemics of the past, we know that it will pass. Whether it will pass in April, May or June, we don’t know. But it will pass.
Looking forward, the domestic debate revolves around how much fiscal stimulus the government will push into the economy and where it will be deployed. Will it be in the form of cash payments to all Americans, loans to small businesses, bailouts to large corporations, or a combination of all these options? I will spare my opinions as they are irrelevant to the conversation.
We are also debating whether we will see a V-shaped recovery, L-shaped recovery or a U-shaped recovery. Only time will tell, but it is my opinion that the shape of the recovery will largely depend on three primary factors:
1) The length of time until social distancing ends.
2) The effectiveness of fiscal stimulus to stimulate/maintain demand and thus limit the depth of the recession.
3) The amount of damage done to corporate balance sheets.
Obviously, all of these factors are interlinked. Together, they will determine how high the unemployment rate spikes and how long it will take to get people back to work.
From an equity market perspective, we have seen a greater than 30% decline in the major averages. As of the morning of Wednesday, March 18th, we are testing the lows from December 2018. It’s important to remember that the decline in the fourth quarter of 2018 was over fears that we would see a recession in 2019. That did not happen, and we saw sharp reversal in stocks. It’s also important to remember that the 10-year Treasury was above 3% back then, today it is hovering around 1%. The monetary response to this crisis will help when we recover.
Through all of the panic and fear, the thing that has impressed me most has been the response of our clients. Naturally and understandably, they are concerned but they have been calm. Personally, I have not received one call asking me to go to cash. In fact, most are seeing this as a buying opportunity. With an intermediate to long-term view, I agree! But has the market bottomed? No one knows. On the surface, it appears that we are pricing in a recession and a significant stimulus package to limit the economic damage. The Treasury market has settled down which is a good sign.
I have sat on many conference calls and spoken to many of our institutional partners. The overarching theme has been that the market will recover and will be higher by the end of the year. One even expects us to get to new highs. In my opinion, those are lofty expectations. But I do believe that when the market turns it will turn up quickly. We must remember that the fundamental value of a company remains the net present value of its future cash flows. In aggregate, cash flows from this year will be lower, meaning stocks should be lower. But COVID-19 should not materially impact the future cash flows of companies, in aggregate, for 2021 and beyond. There will be exceptions. Primarily over-leveraged companies that will be forced to raise capital.
With all the uncertainty, there is one thing I am certain about. Crisis creates opportunity for those with a long-term time horizon. When we build plans for individuals, we discuss finding the optimal balance of income, growth, and guarantees for each individual or family. We inherently know that there will be unexpected events such as 9/11, the financial crisis, and now COVID-19. A proper plan and allocation can weather these shocks.
There will be some longer-term ramifications from this crisis that match a thesis we laid out in our 2020 Economic and Market Forecast. But I will comment on that in a separate commentary next week. For now, all of us at Element Wealth applaud our clients for their rational responses to the recent events, and welcome anyone to reach out to us to discuss their financial future.
Jeremy Nelson, Partner
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