Tax Reminder:
You should have received your 2019 tax documents by now via mail from E*Trade Advisor Services. Also, remember, the transaction data for taxable accounts can be downloaded into most tax preparation software programs via a CSV (Excel) file from the Liberty website. If you need any assistance or would like us to send the digital tax information direct to your tax preparer for you, please let us know and we will be more than happy help.
Morgan Stanley Announces Plan to Acquire E*Trade:
Some of you may have seen the announcement in the past few weeks that Morgan Stanley plans to acquire E*Trade Financial, which would include E*Trade Advisor Services. The acquisition is due to close sometime in the fourth quarter of 2020. At the moment, we don’t have any details as to how this might affect the custody of our client accounts and we should be receiving more information in the next few weeks. We will keep you apprised of this development. As an independent adviser, we can select any custodian for our client accounts that we feel is in your best interest and are not tied to any one firm.
COVID-19 Blamed for Recent Market Declines
Let us first start this article by saying we are not medical professionals and are not experts in any health care issue. We are, however, financial professionals and “numbers” people. With all the information constantly flowing from so many sources over the past week or two, both accurate and inaccurate, regarding the COVID-19 virus, we felt it important to try and put the current situation in perspective relative to these extreme times of market movements. It may be fitting to quote an infamous fictional character who once said, “Boy, that escalated quickly.” As of the date of this writing, the S&P 500 has fallen nearly 13% as of Friday, February 28th since its high back on February 19th, a staggering nine days apart. This drop marks one of the fastest declines although not unprecedented. Black Monday in 1987 was a much more dramatic decline, dropping over 20% in a single day. Interest rates have also fallen (bond prices rise) sharply over the past few weeks, with the current rate for a 30-year fixed mortgage around the 3.125-3.25% range, and the 15-year fixed mortgage now dropping under 3%. (Bankrate.com) What is the reason given for this most recent market decline? Well, if you read the headlines, it is being blamed on panic caused by COVID-19, which is a strand of the common coronavirus family.
Let’s explore some statistics of an even more common illness that grips the US year after year: the flu. So far for the 2019-2020 flu season, the CDC estimates the flu has caused anywhere from 16,000 to 41,000 deaths in the US alone. Yes, this is from a staggering amount of cases estimated at 29 to 41 million. This is a small mortality rate given the number of cases. But nonetheless, the flu still claims a staggering amount of lives every year in the US. So far from this so called “pandemic,” the COVID-19 strand of the coronavirus claimed just over 3,000 lives globally. The mortality rate for developed nations is estimated between 1 and 2%. However, it’s extremely difficult to determine any statistics for the US, as we do not have any significant amount of deaths or even cases for that matter yet.
In order to equate this strand of the coronavirus assault on the US to the flu assuming a 2% mortality rate, the US would need to experience somewhere between 800,000 and 2 million cases of COVID-19. As of writing this, there were an estimated 89,000 cumulative cases since the outbreak and just under 43,000 active cases still pending worldwide. In the US, there are currently only 73 reported cases, with the majority of these being passengers of the Diamond Princess. We do not intend to belittle the virus for any individual having to suffer from this illness. We are simply trying to put into context just how irrational we view this “panic” relative to what the actual numbers are indicating, and data suggests. Most that are unfortunate to contract this virus will survive. And if the media hype around this virus has done anything, it has served as a good reminder to practice good hygiene by washing your hands frequently and avoiding those with coughs or frequent sneezing. However, you should be practicing good hygiene in fear of the flu, not COVID-19. It has already been reported that flu cases have begun falling in Japan, which they believe is due to civilians practicing better hygiene in fear of contracting COVID-19.
Stock Valuations More Appropriate Than Last Month
We had already taken a very cautious approach and moved all our portfolio risk levels to minimum stock/equity allocations based on risk levels in anticipation of some type of market decline in the future as we have communicated last year. We did not know specifically what would cause the markets to fall, and couldn’t predict the current scenario that has unfolded, but were planning to take advantage of lower stock prices at some point in the future. In our opinion, the U.S. stock markets could be more concerned with current political risks and uncertainty in the U.S. as well as excessive valuations, not necessarily the current “outbreak” of a virus that should not currently be feared as much as the common flu statistically speaking. Every sector of the market has seen precipitous declines. Some sectors and specific stocks have fallen much more than others, but it is highly unusual to see such broad declines, with no sectors outperforming others.
One good example of the overreaction of current stock prices is Carnival Cruise Lines (CCL). CCL was a stock that we had felt was trading at relatively attractive valuations prior to the “outbreak.” However, since then, the market began aggressively selling down the stock, which fell an additional 25% since February 19th. The company will undoubtedly be impacted by this virus and travelers’ panic in the near-term, however we look at the stock in terms of its current valuation rather than dramatic concerns for a temporary issue. After this steep decline, CCL is now trading at the lowest multiple in its history. Today, investors pay a lower valuation for the business than at the bottom of the 2008 financial crisis. If we were to have to compare today’s environment against the “great recession’s” economy, we definitely feel the financial crisis would be much more detrimental to the business than today. We would view this as a definite mispricing of the stock. Additionally, energy prices have been in decline, which is roughly 12% of CCL’s operating costs. It does not seem logical to have the business priced in a such a way. It is examples such as this that we are continually searching for in order to invest within client portfolios for the long term. We believe businesses like these that are trading a such significant discounts will bode well for our clients’ long-term investment returns as well as possible protection against more downside.
As we had been communicating over the past several months, we felt markets were getting somewhat over-valued in general and had become increasingly concerned with high valuation levels and expected some type of downturn or “correction” at some point. For the first time since implementing our current stock models (Level One, Level Two, and Level Three), we invested some amounts in each of the stock models into fixed income securities in January of this year to reduce overall risk again. However, we have now started to reverse course and have started to liquidate some of the bond/fixed income funds within the stock models and began investing in value-oriented equities at lower prices and valuations on Friday. As we have discussed in the past, we manage the specific risk for each portfolio risk level and will always maintain some equity exposure given your long-term financial plan.
It May Be Time to Start Increasing Stock/Equity Exposure Once Again
All risk levels for our client portfolios have been at the lowest exposure to equities due to previous internal market concerns that we have expressed over the last twelve months. In most cases, we believe a potentially impending recession could be quite soft and shallow. However, most of these confirmations could take multiple months to be seen. For our higher risk level clients (Growth and Aggressive Risks), this is not something that we feel should be delayed until full confirmation of economic data. Ironically, it was just last month we requested the patience from clients to wait for a better opportunity to begin taking more risk. We had no anticipation that it would only take one month to see such substantial declines. For our aggressive and growth clients, that time may be here, especially if the market declines resume in the weeks ahead. We will most likely begin the gradual process of increasing equity exposure for our more aggressive clients.
What will this look like? We will begin rotating out of our allocation holdings that are currently fully invested in fixed income related funds and continue reinvesting the proceeds into our stock models instead. Our low risk clients may not see this transition for some time; however, our higher risk clients may notice changes as early as this coming week. We would anticipate seeing all portfolios move back to higher levels of stock/equity holdings once again over the next eighteen months. That time frame would most likely be shortened if market declines continue in such a manner as they have these last two weeks. To give some reference of equity exposure, a Moderate risk portfolio currently holds roughly 45% percent of assets invested in publicly traded REITs (Real Estate Investment Trusts) and other equities/stocks. By the end of 2021, we would anticipate these levels to be much closer to 65-70%. However, we will not know the specific timing until we move further into this economic cycle. We will keep you in the informed as this planned transition occurs. Again, our more aggressive clients will be making the transition before more conservative clients.
All of the economic signs that gave us concern in months past still exist however equity markets are typically looking forward, not a reading on today. Therefore, we have to continually be looking at where the puck is going, not where it’s been, the best we can. As we have discussed in the past, economically sensitive stocks have seen substantially depressed valuations/prices, which lead us to believe the next recession will be more subtle whenever it does come. We do not pretend to know the future; we just believe the current forecast has been giving us reason for caution. But when you get a 15% reset in prices/valuations within two weeks, it opens up the opportunity to purchase stocks on sale from just the month before. “Buy low, sell high”.
Within the individual stock models themselves, we have been reassessing every position held. We may take the opportunity to liquidate some positions to either overweight others or purchase even more attractive companies that have taken an unnecessary beating during this recent market decline. Reflecting on the Carnival Cruise Lines example above, CCL doubled the market decline, causing the company to be even cheaper in terms of relative value. For this reason we remain diligent in constantly searching for new opportunities as prices continue changing ever so quickly everyday.
CDC reference: https://www.cdc.gov/flu/about/burden/preliminary-in-season-estimates.htm
COVID-19 Statistics: https://www.worldometers.info/coronavirus/
We realize this is an unusually long update but felt it important to provide you with updated information given the current situation. We wanted to share our thoughts and current outlook and plans at present. As always, please don’t hesitate to call if you have any questions or concerns, or if we can be of further service in any way.
God Bless,
Your TEAM at F.I.G. Financial Advisory Services, Inc.
Uncertainty and Volatility