COVID-19 Active Cases Increases in U.S.
As we have been saying in previous updates, the COVID-19 active cases were expected to increase in the U.S. this past week and the coming week ahead. As more testing occurs, we would expect more reported cases. As of today, there are 134,902 active cases reported for the virus, with 55,111 of those in New York alone. To date, there have now been 2,475 deaths in the U.S. due to the COVID-19 virus, or 1.7% of the total reported cases so far of 141,812. (Worldometeres.info). After the financial markets rebounded at a record percentage for just one week, we still expect market volatility to continue until the end of the virus is in sight. This could be for another month or so, but hopefully sooner. We will keep monitoring the situation and keep you advised.
Stimulus Bill Passes
After much delay and disagreement between both the Senate and the House, the third phase of the Coronavirus Aid, Relief & Economic Stability Act, has been passed. It provides $2 trillion of stimulus to everything from individuals to businesses and even state and local governments. A local law firm has provided a very detailed analysis for individuals as well as small businesses, which we would direct you their website for more detailed information. The two major points being every individual with less than $100,000 of income or family less than $200,000 of income will get some form of stimulus check from the government. The actual delivery is still being discussed, but it will provide relief to many Americans. As for small businesses (companies with less than 500 employees), they will be able to apply for loans roughly 2.5 times average monthly payroll and other related expenses. Additionally, if the proceeds are used for specific purposes, the entire loan balance will be forgiven on a tax-free basis over an eight-week period from the inception of the loan. These funds are also made available to non-profits, sole proprietorships, and self-employed individuals. We will be actively working with local banks to determine the details of this program and intend to help assist any client that is eligible for the program. Please do not hesitate to reach out to us for further information. We will be attempting to proactively contact each of our clients that qualify as a small business, once we have more details. However, we encourage you to reach out as well. Since the President recently announced social distancing measures being extended to April 30, we believe these loans will be able to help most small business owners through these uncertain times.
Inflation Concerns Elevated
We do continue to be baffled by the intense fear infused in the media for this event that seems less severe than the dangers of past pandemics, however it is the environment we are trying to actively manage. Our attention remains acutely focused on the financial markets as well as the potential impact from both the Fed’s actions, government stimulus, and issues occurring due to businesses being forced to close. The historic stimulus package was signed by President Trump on Friday, after facing unexpected delays in both the Senate and the House. We believe this package will plug the massive liquidity hole that has been created, however there will undoubtedly be hiccups over the next few weeks as businesses and individuals try to get capital from the various programs. Additionally, the government is paying out benefits directly to many Americans, in an unprecedented move. We have long-term concerns for these actions, and we believe most are ignoring the massive amount of inflation risk that follows. We do believe this event could cause some longer-term issues, however, in our opinion, the current investment valuations seem to account for this risk.
For those that hear about individuals moving their assets solely to cash and do not intend to ever reinvest, we would have major concerns for this strategy. We believe the purchasing power of savers could be materially eroded over the decade ahead, and we intend to help protect clients from these risks. Future inflation continues to be the greatest risk, in our opinion. We do believe this crisis is indeed a massive issue, however we believe most investments we are purchasing have already accounted for many of these risks. If we were paying record high valuations like one might for an example in Clorox’s stock, we believe this could have detrimental impact to a portfolio. However, we remain on the opposite side of this example, purchasing investments at the cheapest valuations we have seen, in some cases, on record.
Bond Investments
As for our bond investments, we finally began adding back to specific bond funds last week. In particular, we saw municipal bond yields higher than those of treasuries. This is highly unusual, as municipal bonds have tax benefits that typically cause yields to be less than that of treasuries. We believe this occurred from the uncertainty of repayment by municipalities that will face difficulties in the months or year ahead, however we felt our clients were now being appropriately compensated for this risk. We also added back to our asset-backed security (ABS) strategies. These strategies are typically safer in nature, as the bond is secured by some type of asset.
At the time we liquidated all bond funds, these bonds seemed to have very little risk priced-in moving forward. Since that point, prices have fallen substantially, allowing us to get back into the investments at a much more appropriate risk/reward level for clients. We believe this will substantially improve total returns over the years to come. We have not begun buying riskier bonds such as high-yield corporates or bank loan debt. We intend to begin this over the following weeks if these bonds see further price declines from increasing credit spreads. We also invested in extremely high-quality corporate bonds as a place for safety as well as inflation-protected bonds, in the event we do see the eventual rise in inflation risks. We do believe we are in the midst of a short-term liquidity crisis, which typically comes with extreme deflation. Therefore, we are not concerned with any short-term related inflation risks. Our focus remains on inflation risks for the years to come, and we want to try to be early in helping protect clients from this future risk. In the short term, this does increase our concern for a near-term spike in longer term treasury rates.
Another example of an interesting part of the fixed income market at present are mortgage backed securities (MBS), specifically those guaranteed by the government. The current market is not set up to handle such an unprecedented event that we face currently, however it is creating unusual opportunities in assets trading substantially below their guaranteed values. If events get substantially worse, it could cause a delay in guaranteed payments. We believe much of this market is also facing forced liquidations, which are causing further price declines for no other reason other than firms being forced to sell at any price. Companies such as mortgage REITs (Real Estate Investment Trusts) buy these assets through leverage, or debt. This allows them to amplify returns. However, with the recent wild price fluctuations we have seen, it is causing firms like this to have to sell the leveraged assets causing further price declines. None of this is rational nor is it their fault besides taking too much risk with leverage. If an asset is guaranteed at $100, it would be easy to assume that asset will trade near $100 in a worse-case scenario. The other impact to these assets is interest rate risk. The recent market environment has reduced these assets well below $100, which is causing issues most of these firms were not prepared to deal with. We also believe this is creating substantial opportunities in relatively secure investments.
Value Based Investing
As for clients’ equity exposure, we continue to rely on individual stock holdings and publicly traded REITs. Most of our positions held are now trading at historic low valuations, which we are presently encouraged for the long-term opportunities presented to clients. A majority of the positions held are in some way impacted by the virus fears or the eventual demise of the economy. We believe many of these types of companies have been overly discounted and aggressively priced to the downside, allowing for some margin of safety moving forward. From our perspective, these securities should recover much faster than other stocks as the virus passes. If the economy appears to be in a more severe decline at that time, we should then be able to slowly sell off these securities in favor of other stocks that have simply been impacted by the economic decline and may now present better values at that point. At this time, however, considering how fast prices have moved, this becomes a constantly evolving situation in which we continue to find new opportunities almost daily.
We do agree with most about the severity and issues at present regarding the economy from this event. However, we continue to believe it will be much shorter-lived than most expect allowing for above average long-term opportunities. Additionally, we are focused on what we are paying for these investments in terms of valuation. We believe the investments currently being purchased in client accounts are in many ways priced for the “worst case” scenario. If we did not believe so, we would not see this as such an incredible opportunity. We believe that the current investments held by clients should perform well relative to other investments if the worst-case scenario does indeed unfold. However, if anything other than the worst-case scenario should occur, we believe portfolios will see above average positive results relative to the markets in general as the financial markets re-price and rational decisions are made again.
We’re seeing countless irrationally priced stocks that we strongly believe patient investors will be pleased in the decade ahead by the opportunities being given currently, regardless of what price fluctuations come in the months ahead. One may witness a short-term price decline in the weeks/month ahead, but we have been provided opportunities to acquire more stocks at this time for the possibility of long-term positive results. We want clients to remain focused on the years ahead and not get lost in the current panic or fears even if they become more dire in the coming weeks. The market has started looking ahead, and the majority of companies that we are interested in are trading at extremely low valuations. This rarely happens, and we continue to be excited about the long-term potential of these investments. It’s easy to assume that just because events worsen in reality that markets will also worsen. However, that is rarely the case. In general, markets also tend to dramatically overshoot to the downside, initially pricing in much more severe outcomes than actually occur. We believe this overshoot has occurred in many of the stocks we are buying, which would imply if events do indeed worsen, then in reality these holdings should fare better than others. We will keep you advised.
Please call or email us at any time if you have any questions or concerns. Also, we can set up your personal online review as well. We are now almost to the end of the first quarter of 2020, and this would be a great time to schedule a review of your long-term plan and personal portfolio and risk.
God Bless,
Your TEAM at F.I.G. Financial Advisory Services, Inc.
Looming Risks Overlooked