As we have previously reported to you, we were more conservatively invested based on each of our risk levels going into this current market decline. This type of positioning typically means we were more heavily weighted towards fixed income/bond funds. In stock market declines and slowing economic activity, this usually is a prudent approach. We had been using bond funds to help protect portfolios during stock price declines. We now have some concerns that the markets might not be able to support these fixed income assets during a liquidity crisis. In terms of fixed income/bond fund exposure, we have most of our exposure in shorter-term funds as well as securitized securities. The current market over the past few days has been unable to fully support even these safer, short-term bond investments. Therefore, our bonds have declined some in value over the last week, though much less than equities. We believe the Fed will continuously increase their capacity to buy bonds to help alleviate this crunch, but this is for the short-term. We want to have cash readily available to begin buying other assets as early as next week. We do not want to risk not having access to cash funds needed to accomplish this. We have verified with our custodian, E*TRADE Advisor Services, Inc. that all cash assets are held in liquid cash and not swept to a money market fund. For this reason, we fully liquidated all of our fixed income bond funds we hold as of today’s market close. These funds, for now, will be held in cash for stability moving forward.
We do think these types of fixed income investments should get back to normal after the liquidity crisis passes. But, that’s not our concern. Our concern is the next few months moving forward for those assets. We utilize these fixed income assets to help offset, to some degree, stock declines, and we do not believe they can achieve this over that period. We have not sold any stocks at this time, and we will eventually increase exposure to equities over this period. However, if we are waiting to increase exposure to stocks/equities but also lose value in the assets we intend to sell at some point (the bond funds), we could see value declines on both sides. For this reason, we believe cash is the best holding spot for the next few weeks. We do not believe cash is a good long-term investment and are actually concerned for currencies once the dust settles. Furthermore, the concern extends to the validity of any currency value after this extremely short-term liquidity crisis. Consequently, a liquidity crisis will make cash valuable for a short time, until people have regained level heads.
Let us walk through the functioning of the debt markets.
The US is nearing $3 trillion in commitments by the Fed and US government to offset the potential result of COVID-19 so far. Another $1 trillion is being discussed today. The US will have the highest amount of capital injected into this by the time it passes, as would be expected given the US economy is the largest. Pretty much every government worldwide is taking similar measures to address liquidity needs. Typically, governments raise capital through the bond markets. They “sell” debt (bonds) to people who in turn pay cash. Governments worldwide will not be able to do this especially at the speed needed. Think of a marketplace that everyone is trying to sell something where there is no demand at present. China is the only country currently back to business. Governments will have to turn to their central banks which will have to create the capital to inject into the system by directly buying the government bonds. In most cases, it’s less of a concern in small doses. It can be a good band-aid, but usually it is not happening in every corner of the world at the same time and at such extreme measures. There isn’t enough cash in the system at present to handle this. Governments will need cash immediately and decisions could be rash now but should subside over the coming months. The amount of dollars created over the next few weeks will be needed in the short-term, due to the globe shutting down economically.
“This is not the time to worry about [deficits]” … US Treasury Secretary Steven Mnuchin
“The stimulus has no cap and will inevitably impact government debt.” … Dutch Finance Minister Wopke Hoekstra
So far, Germany and Spain’s proposals currently exceed 16% of their Gross Domestic Product, (Their economy). So again, we have to think about what happens when we wake up in three months with this having passed?
We believe the amount of capital the Fed and US government will throw at this will far exceed the capital thrown at the financial crisis or any other country’s stimulus efforts as well. We believe they have no choice, but we also believe it will be temporary and will stave off a collapse. Through this process and once we emerge from the panic, we believe businesses will be what you want to own as stockholders. We believe stocks will resume normalized multiples over the next three to five years, giving investors an opportunity today that we rarely see. Those that remain calm knowing this will pass and take this opportunity to buy stocks, should benefit in the long term. We would expect this panic could continue for at least two weeks or so as active cases continue to surge. So please, remain calm and enjoy time with your family at home. We cannot predict what will come in the days ahead, but we are firm believers in the years and decades ahead. Entire business valuations are fluctuating by more than +30% each day. This is not a rational environment and will most likely remain volatile. Ultimately, rational minds will prevail.
We are here to answer any of your questions or concerns and appreciate all of the support and words of encouragement we have received from many of you. We will keep you updated as often as needed to inform you of any changes as they occur.
Your TEAM at F.I.G. Financial Advisory Services, Inc.