Stocks Rebound, Economy Uncertain, Hedges Implemented

Office Schedule/Plans:

We have been working remotely over the past several weeks and are planning to be back at our office starting Monday, April 27^th.  We have been conducting several reviews and updates online in the month of March as well as April.  We can still schedule online reviews moving forward but will also be available for “in-person” meetings again starting the week of April 27^th.  We are looking forward to the beginning of moving back towards a “normal” life once again, as we are sure all of you are as well.  We have been blessed as none of our family members has had to deal with COVID-19 virus and our goal is to stay healthy moving forward in order to continue to serve all of you on a daily basis.

The Markets:

Markets bounce off the bottom reached on March 23^rd. Since last month’s low, the S&P 500 Index rallied 29% through April 17^th.  Technically, a 20% rally from the market’s bottom constitutes a new bull market–“technically”. As of April 17^th, the S&P 500 Index was 15% below its February 19 peak (Investing.com). The recovery has been cautiously encouraging, and we believe there are three variables that can be cited.

First, the federal government passed the CARES Act. The bill includes over $2 trillion in spending, generous jobless benefits, loans and grants to businesses, stimulus checks, and more. It offers a much more aggressive response than in the 2008 financial crisis. More will be needed, but it’s a good start. Congress is currently at odds about further stimulus, which would be expected to come. The SBA payment protection program has exhausted all of its allocated capital for small business, which now needs additional action by Congress to increase. The industry claiming the highest amount of loans was the Construction industry at 13.12% of the $350 billion in loans. The next highest was Professional, Scientific, and Technical Services at 12.65%. Manufacturing was next at 11.96% followed by Health Care and Social Assistance at 11.65%. Oklahoma business claimed roughly $4.6 billion over 35,557 applications. Not surprisingly, California and Texas claimed the most at $33.4 billion and $28.4 billion respectively

Second, the Federal Reserve has aggressively responded. Pre-crisis, there were questions whether the Fed had the necessary tools in its tool kit, given that interest rates were already low. Apparently, they do. With much greater speed than in 2008, the Fed has launched numerous programs aimed at propping up the economy–from big business to Main Street. The two-pronged attack has not been executed flawlessly, but it has cautiously encouraged investors to dip their toes back into stocks. While the economic outlook remains fluid, investors are trying to discern some form of an economic recovery in the second half of the year. Remember: The stock market is always forward looking.

Third, there are signs the virus may be peaking. An April 12 headline in Bloomberg News offered a cautiously upbeat headline: “CDC Says U.S. Near Peak; 70 Vaccines in Pipeline.”  With signs that new cases may be peaking, talk is surfacing over how to best reopen shuttered industries. Encouraging information continues to unfold from the health care space concerning the threat of the virus. The US government also recently announced a three-phase process to opening the economy back up. Many states already meet the criteria to being phase one, which the President has indicated it is the decision of each Governor to make for their respective State.

Portfolios’ last major rebalance occurred on March 23, which coincided with the market bottom at this point. Since then, as we mentioned earlier, equities have run up dramatically with the S&P 500 jumping more than 29% from its low as of April 17^th. (Investing.com) We remain very  optimistic for the years ahead, and we have been encouraged to be able to start buying certain stocks at what we believe to be rock-bottom valuations. However, we do strongly believe many problems still exist and will for some time. Rather than reducing our exposure in companies that we find attractive we have chosen to hedge portfolios by shorting specific markets using Exchange Traded Funds (ETF’s) that move opposite the respective category. We see larger problems with specific areas such as emerging markets. Additionally, we do have concern for many Eurozone nations, which do not own their own currency. The US has chosen to endlessly shower money on any issue with no thought for the future cost or consequence. We do believe this will lead to long-term higher inflation and devaluation of the US dollar however, most EU countries do not have this option since they cannot “print” money themselves. We think it is possible that this dramatic of an event could possibly lead to further breakup of EU nations. As for emerging markets, these economies could potentially be devastated by the grinding halt in the world’s economy. These countries cannot afford to take the measures that most developed nations have, even though the EM countries are significantly less impacted by the virus itself. The economic destruction could be devastating for them over the coming year or two.

For aggressive and growth clients, we have chosen to hedge much less of the equity/stock exposure, as these clients anticipate and understand greater price volatility. For our Growth, Moderate, and Conservative risk clients, we have hedged roughly 20% of equities and the Capital Preservation risk level has 20-30% hedged by shorting these specific markets. Our plan is to fully exit these hedges if markets do take a turn for the worse in the months ahead, which is very possible in the shorter term. Accounts will undoubtedly be impacted by markets turning lower again, but to a much lesser extent than they would have without these “hedges”. If the future does play out this way, we would anticipate selling these “short” funds and reinvest into equities at lower prices. For long-term returns, we do see this as the most ideal situation, although it may not be the most comfortable. On the other hand, if equity markets instead continue higher, we will continue to hold these short positions until more certainty is seen on the horizon. We do not pretend to know what markets will do in the months ahead or what direction prices will go. We have simply chosen to add some protection in the event more uncertainty and negativity arises, which we do see as a very real possibility in the months ahead. We continue to be optimistic for the years ahead, however we are choosing to try and soften any potential near term volatility for clients, if it does come.

The Economy:

Second Quarter Gross Domestic Product (GDP) will be Ugly:

The St. Louis Federal Reserve estimates that GDP, the largest measure of economic activity, could contract at an annualized pace of 50% in Q2. That’s unprecedented. Yet, forecasts vary widely. In reality, we don’t know how steep the downturn may be during the April-June period.

In just a three-week period, the number of first time claims for jobless benefits totaled an astounding 17 million (Dept. of Labor). For perspective, during the 18-month long 2007-09 recession (as defined by the NBER), first-time claims totaled 9.6 million. A sharp contraction in the economy in Q2 is expected, and layoffs are the first, bitter fruits of the economic crisis. We are in uncharted economic territory, and the future is quite uncertain. On the other hand, the amount of Government stimulus added to the economy this time is also unprecedented compared to any past crises. All the programs put into the economic system, including the special unemployment program, provides hope that the economy will possibly come back quicker that what we have seen in the past as well. The rally in stocks is an attempt by investors to look for an economic bottom and eventual economic recovery. Remember, no one rings a bell that sounds the all-clear signal. Collectively, markets attempt to price in future events. We would still expect large daily swings, both to the upside and downside, to continue amid the uncertainty.

We don’t want to downplay the havoc created by COVID-19. We are living in a world that nobody could possibly have envisioned a few months ago. The impact caused by the virus has disrupted life around the globe. Yet, unexpected blessings have surfaced. People are reaching out to family and friends via texting and emails or online meetings. Some are even connecting the old-fashioned way–by phone. Families are becoming closer than they have ever been before. Activities and jobs around the country have been suspended but not ended. And we are confident we will see an economic recovery take root and the pandemic will subside. Together we will get through this dark night, and we will be stronger for it. We see light at the end of the tunnel as the Country opens back up for business again.

We are here for you and are available if you have any questions or concerns, or if we can be of further service in any way.  We appreciate the privilege to serve all of you today and in the years to come.

God Bless,

Your TEAM at F.I.G. Financial Advisory Services, Inc.

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