MARKET COMMENTARY - Fredric W. Williams
Awash in Superlatives…
“The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.”
- Warren Buffett
To say that Q1 of 2020 was “interesting” may likely turn out to be the understatement of the year, given the number “firsts” that were compressed into less than the last 45 days of the quarter. The record 11-year economic expansion culminated with the domestic equity markets hitting all time highs on February 19th, after which those same markets suffered a bear market decline of around 27% in just over a month (the fastest ever), which was then followed by a bull market rebound of more than 20%...in three days - another first. Oil prices declined 66% to 18-year lows as a result of a price war between Saudi Arabia and Russia, who were unable to agree on petroleum production cuts to reduce the expanding glut in global oil supplies. While professional sports worldwide, the epitome of large public gatherings, ground to a halt over health concerns, we then saw the PGA, NBA and NHL suspending their seasons and MLB putting an indefinite delay on opening day. This cascade then culminated in the unprecedented closures of businesses and non-essential retail operations that brought the global economy to a near standstill.
And we all know that what drove this list of “firsts” were the ongoing efforts to mitigate the spread of COVID-19 as it traveled from East Asia, through Europe and then into North America, following – interestingly enough – the well-worn global trade and business travel routes. What started as a challenging public health issue as it addressed the spread of a respiratory virus, morphed into a required societal shift in activity (social-distancing progressing into stay-at-home orders) which stopped global economies in their tracks. The uncertainty surrounding the duration of this shut down, or the magnitude of any associated recession, resulted in equity markets around the world pulling back from their highs while they assessed the monetary policies and fiscal stimulus that governments were marshalling to combat their stalling economies and then revive them from what have basically become medically induced comas.
Inevitably, these circumstances have fostered numerous “first time since” comparisons – with the bulk of that attention focused on the ’08-’09 downturn. And although the magnitude of this quarter’s initial price decline may have caused a similarly disconcerting gut-check, especially since the 12-year gap may have pushed those previous reactions into investors’ mental archives, there are some significant differences that exist which might bode well for the other side of the bell curve.
During the Great Recession it took months for the government to cobble together a patchwork of fiscal and monetary actions – this time, although we’re still awaiting rollout effectiveness, we’ve seen that take place in thirty days. In addition, our basic economic underpinnings are in far better shape than they were a decade-plus ago:
“Credit quality is much higher than during the financial crisis. There are far fewer subprime loans. And the regulatory regime has been completely retooled.
“Consumers are in far better shape than they were heading into the last crisis…in 2007 we had the highest household debt-service ratio in history…we entered this with the lowest house-hold debt-service ratio since 1981, and a positive savings rate.
“Banks are also far better capitalized than they were in the past and are subjected to regular stress tests designed to ensure they can make it through the toughest times. Going into the financial crisis, large U.S. banks had about $7 for every $100 in assets, while large New York banks had just $5. Today they have $10 for every $100 in assets. That’s a bigger cushion to absorb losses in hard times” - A. Root, Barron’s 4/3/20
With economic activity being the interface of supply (producers of goods and services) and demand (the users of those goods and services), the world is now experiencing a self-imposed demand-shock as businesses, individuals and families have been severely curtailed by a multitude of closure and stay-at-home limitations on their otherwise everyday lives. This underlines the significance of consumer activity in our GDP (about 66% coming from what you and I spend), and it also suggests that as this public health issue recedes there could be significant pent up demand once the above referenced limitations are relaxed.
Bear markets occur regularly, as do recessions, and the one thing they have in common is that they do eventually end. Within the S&P 500 there have been 25 bear markets and 26 bull markets since 1928, and the U.S. economy has had 11 recessions since 1945. The average bear market lasts 10 months and the average recession 11 months – and since we can’t avoid them the goal is to appropriately navigate them.
We don’t know exactly when we’ll be on the other side of this where the market stresses will be abating, but it’s instructive to review one’s approach to the normal ebb and flow of the capital markets. A great overview of this dynamic can be found in Benjamin Graham’s “treatise”, The Intelligent Investor, where he describes the differences in temperament between longer-term investors and shorter-term traders:
“The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices…price fluctuations have only one significant meaning – an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.
“The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage…” - Published in 1949
And although this public health issue continues to be challenging economically, to say nothing of the human and emotional toll, we are starting to see glimmers of a return to normalcy in areas of the globe where the virus is on the back side of its normal life cycle:
“Parts of the world are already in recovery. China and South Korea are recovering from their peak in Covid-19 cases and related business shutdowns…Even the Chinese city of Wuhan, the epicenter of the epidemic, will reopen in about a week. Together these two countries account for about 20% of the world’s population and economy.
“With the threat of the virus receding, economic activity is reviving in Asia. Economic indicators we can measure daily – or even hourly – like road traffic, air pollution, and port activity all point to a pickup. Early official monthly data reports for March seem to support these signs of recovery. For example, last week’s data on South Korean exports measuring the first 20 days of March showed a monthly rebound of over 50% in goods sent to China.” - J. Kleintop, CFA, Charles Schwab 3/30/20
Perhaps not yet totally clear of the global turbulence associated with this healing process, both on an economic and human level, but a thoughtful and calm leadership perspective may be the needed light to help guide us the rest of the way through:
“While we’ve faced challenges before, this one is different. This time we join with nations across the globe in a common endeavor, using the great advances of science and our instinctive compassion to heal. We will succeed – and that success will belong to every one of us.”
- Queen Elizabeth II 4/5/20
CAPITAL MARKETS OVERVIEW - Francis J. Davies, III
Domestic and Global Market Recap
No amount of federal interest rate manipulation or quantitative easing can hold back inevitable economic reality forever. – Domestic and Global Market Recap, October 2019
Life during the COVID-19 pandemic: wearing a surgical mask and nitrile gloves; not seeing anyone outside the immediate family; spending hours on Zoom meetings; trying not to let fear dictate. Each week in March felt like a month as global markets gyrated in response to a fire hose of news, governmental actions (or inaction), a complete shutdown of business and social life, and a global mortality rate not seen since the Spanish flu of 1918.
News of the “pneumonia of unknown cause” emerged in early January. The first case in the US was reported on January 20, around the time that the federal government began bringing back Americans from affected areas of China. The markets did not pay much attention as long as it appeared to be contained within China but the outbreak spread rapidly outside of China, with Iran, South Korea and Italy reporting a surge in cases. The market began to teeter February 19 and collapsed February 24. The S&P 500 ended the day down 3.3%, ending the second longest bull market in history, after nearly eleven years and a 401% gain in the S&P 500.
The pandemic over-shadowed the collapse in the price of crude oil. Russia and Saudi Arabia had begun a price war before the coronavirus appeared, but the breakdown in the global economy cut the price of West Texas Intermediate, which had been trading around $60/bbl in December, to an 18-year low at $20/bbl. Adjusting for inflation, that is cheaper than back in the 1960s, a level at which most US production is unprofitable. Domestic energy workers faced indefinite layoffs and their employers saw their stocks and debt trade near bankruptcy levels.
From the high on February 19 to the low on March 23, the S&P 500 fell 1,150 points, a 34% drop in 23 trading days. An old Wall Street adage states, “the market takes a staircase up and an elevator down.” For reference, the record quarterly drop for Wall Street was 40% in 1932 during the Great Depression. Volatility was off the charts with the week of March 9 – 13 one for the record books. Over the five days, the S&P 500 jumped or plunged between 4.9% and 9.5% a day, triggering circuit breakers, which temporarily halt trading, ending on March 13 with a gain of 9%, most of it in the last half hour. For the quarter, the S&P 55 fell 20%, the biggest quarterly loss since the Global Financial Crisis (GFC) in 2008.
Conditions were ripe for a market correction. Domestic GDP had peaked Q3 of 2018 and the illusion of growth was held together with record stock buy backs financed with record levels of corporate debt. A late cycle economy inevitably leads to a period of contraction. We pointed out this reality in October, stating “The average length of economic growth without a significant downturn is about 39 months. At over 120 months, the current cycle is very long in the tooth. No amount of federal interest rate manipulation or quantitative easing can hold back inevitable economic reality forever.” Economic reality is the balance of supply and demand, and the global shutdown impacted both.
The U.S. was the go to choice for safe haven investing, with government bonds up 13% and the dollar soaring against emerging market currencies. The US 10-year yield dropped from 1.92% to 0.63% over the quarter, while the two-year yield dropped from 1.57% to 0.23%.
Things were no better in foreign markets. In London, the FTSE posted its worst quarter since autumn 1987, shedding 24.8%. European stocks had their worst quarter since 2002 with Spain down 28.9% and Italy 27.5%. Growth in Europe was already fragile, up just 0.1% in Q4 2019. A flash read of the purchasing managers’ index for March revealed a record low of 31.4, compared to 51.6 in February. The PMI includes both the services and manufacturing sectors, and an index reading below 50 indicates economic contraction.
The Japanese market fell and then recovered a little to finish with a loss of 17.5%. The postponement of the Tokyo Olympics for one year to July 2021 added salt to the wound. Emerging market (EM) equities fell heavily in Q1. The oil plunge crushed the Russian markets, down 40% in dollar terms, and Brazilian shares, which lost 50%, with currency weakness amplifying negative returns. China saw its markets fall 11% in dollar terms but outperformed the MSCI Emerging Markets Index as the number of COVID-19 cases declined, and economic activity began to resume.
In the credit markets, high yield and emerging market bonds fell significantly given the aversion to risk, while investment-grade corporate bonds also saw declines. For several days, companies were unable to issue bonds although this improved later in the month.
Commodity markets were especially hit hard in March as worldwide government quarantines and shelter-in-place orders will likely result in a significant decline in global energy demand. Along with oil, copper, aluminum, and steel down 15-22%, agricultural staples coffee and sugar were down 17% and 10%. In contrast, the price of gold hit its highest level in seven years at one point.
First quarter 2020 earnings won’t be available until April, but it’s no secret that the numbers will show a staggering decline. Most pundits that we read predict even worse numbers for the second quarter. Any economic forecasts for later in 2020 are essentially useless until we understand the full effect of the recession we are currently in. The biggest part is rising jobless claims. Morgan Stanley chief economist Chetan Ahya forecasts the U.S. economy to contract 30.1% in Q2, with the unemployment rate jumping to a record 12.8% before the economy bounces back by 29.2% in Q3.
America will make it to the other side of this crisis, as it has after every other crisis. It will not be a quick fix and though it might be easier to tell people that there is nothing to worry about, that will not help anyone in the long run. With decisive leadership and input from original thinkers, we could see positive changes from our current pain with the renewed interest in stakeholder capitalism. Stop using taxpayer funds to prop up overleveraged failing companies; reexamine a system in which big-company CEOs last an average of five years and are motivated by short term stock gains; refocus on longer term investments like capex, research and development, a trained workforce. Companies might learn completely new ways they can support people and communities.
SECTOR OVERVIEW - Richard “Chip” Harlow
US stocks declined sharply during the quarter as a novel coronavirus, COVID-19, became a global pandemic. Confirmed US cases rose from 150 to over 100,000 between March 4th and March 27th, and the economic impact grew clearer but uncertain as to the degree of negative impact. All sectors saw significant declines. Energy stocks were especially hit hard, with the addition of the oil price war weighing heavily. Financials and industrials also fell sharply. The information technology and healthcare sectors held up relatively better. The range of declines were between -50.5% to -11.9%, with the S&P500 falling in between at -19.6% for the quarter and year-to-date.
Technology
The Information Technology sector held up relatively well during the first quarter, declining “only” 11.9%. While it is still too early to tell how the overall economy will fare, this pandemic has shown that technology will help us manage through it between computer power needed for everyone to work remotely and hold video conference calls to computer power need to run AI (Artificial Intelligence) algorithms in the search for therapeutics and vaccines. Telemedicine, again using technology has also come to the fore-front. While there are concerns about consumer spending and sourcing of materials, the sector should weather this storm. Valuations have certainly come back to reasonable levels and forward looking positive macro themes haven’t changed.
Health Care
Healthcare was second best sector, declining 12.7% during the 1st quarter. It’s probably not surprising that this sector held up relatively well during a global health crisis. The Health Care sector includes health care equipment and supplies, health care providers and services, biotechnology, and pharmaceuticals industries. All of these areas are involved in the fight, from making N95 masks, providing disposable supplies to hospitals, to manufacturing respirators and testing for the virus and antibodies. Almost every part of this sector is actively involved. This pandemic has also shown that the US was woefully under-prepared, and so Healthcare should see some strength in demand for the months to come.
Energy
Several factors turned in the Energy sector’s favor late in 2019, and it all came to screeching halt as Q1 finished down 50.5%. WTI and Brent crude oil posted significant losses in Q1 after the outbreak of Coronavirus weighed on demand and OPEC and Russia had a standoff regarding the cutting of production. While the Coronavirus was wreaking havoc with the US and global economies, Russia and OPEC continued to produce unnecessary output, in part to push marginal producers in the US out of the market. At the end of the quarter however, there were talks between OPEC and Russia about a plan to stabilize the price of oil. It remains to be seen if this will help stabilize the commodity prices. The energy sector was already undervalued, but with this uncertainty in commodity prices and economic activity, valuations become very suspect.
FIDUCIARY CORNER - Stephen L. Eddy
The Impact of the CARES Act on Retirement Plan Distributions…
Greetings everyone, I hope you are all healthy and safe as we go through this unprecedented time. I wanted to update you on the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 and the impact it will have on retirement plan participants. In addition to the much-publicized stimulus checks, the $2 trillion+ stimulus package signed into law on March 27th also provides relief to plan participants through temporary retirement plan provision changes. These include:
- Allowing participants impacted by coronavirus to take a hardship retirement plan withdrawal through December 31, 2020 without 20% mandatory federal tax withholding or the 10% early withdrawal penalty
- Taxes would need to be paid so it’s not a free ride, but it eases short-term access barriers
- In plans that allow participant loans, participants impacted by coronavirus can take plan loans of up to 100% of their account balance (up from 50%) and up to $100,000 (up from $50,000) through September 23, 2020 (180 days from when the law was enacted).
- The platform providers don’t expect this to be a significant change as most people will not be in a position to take on more debt
- In plans that allow participant loans, until December 31, 2020 participants impacted by coronavirus can elect to suspend loan repayments for up to one year.
- This will be widely adopted by eligible participants. It essentially extends the loan term for a year – a five-year loan would become a six-year loan. There will be additional interest that accrues as the loans are re-amortized after the suspension period is up.
- For everyone, Required Minimum Distributions (RMD’s) for 2020 may be suspended by participants and IRA owners.
- This eliminates the need to sell assets in a down market and allows savings amounts to rebuild (note that the SECURE Act passed in December changed the RMD age from 70 ½ to 72).
- For everyone, the IRA contributions deadline is extended until July 15th, 2020 to match the new tax filing deadline.
So who qualifies as “impacted by coronavirus” as it relates to an individual distribution or loan between January 1 and December 31, 2020? The CARES Act provides the following definitions:
- An individual diagnosed with COVID-19 on a test approved by the CDC
- An individual whose spouse or dependent is described in a) above
- An individual who experiences adverse financial consequences as a result of:
- Being quarantined
- Being furloughed, laid off, or having work hours reduced as a result of the virus or disease
- Being unable to work due to lack of childcare due to such virus or disease
- Closing or reducing hours of a business owned by such individual as a result of such virus or disease
- Other factors as determined by the Secretary of the Treasury or his delegate
Item c) is a catch all that will apply to many participants and the most likely option under which they will qualify.
It appears that most plan platforms are activating these options for retirement plans automatically. Given that the broad definitions of impact will likely mean that many participants will qualify for the distribution easements.
Please reach out to Old Port Advisors if you have any questions or need any clarifications. Be patient and stay safe.
Financial Planning and the Coronavirus - Tracy Rogers
The novel coronavirus known as COVID-19 has impacted all parts of our lives. These far-reaching impacts affect our social, physical, mental and financial well-being. Let’s focus on the financial planning aspect of the virus’s influence. Apart from the market gyrations that saw asset values drop 30% and then rise 20% only a few weeks apart, various financial planning tools have jumped to the forefront and highlighted the need to have financial and estate plans in place. Since there has been a recent uptick in requests for wills and estate plans, and applications for life insurance – most likely due to the fact that people are facing their own mortality in these uncertain times – we thought it would be helpful to review a few key components of planning and some timely strategies that might help.
The Proper Estate Plan
A proper estate plan has the following components, where applicable:
- Financial Power of Attorney - gives an agent authority to carry on financial affairs on your behalf
- Health Care Power of Attorney - gives an agent authority to make health care decisions on your behalf
- Advanced Health Care Directive - allows you to specify end of life treatment, life support etc.
- HIPAA Waiver - allows an agent to access medical records and ability to speak with providers on your behalf
- Last Will and Testament - instructions for distribution of assets and guardianship for children, if applicable
- Updated Beneficiary Designations – covers insurance policy, annuity, IRA and retirement plan distributions which are not part of the estate covered by the will, but essential nonetheless
IRA Coronavirus Related Distributions (CVD’s)
The CARES Act that became law in March allows for the following emergency distributions from retirement account assets. The Fiduciary Corner article covers the options for employer-sponsored retirement plans. For Individual Retirement Accounts (IRA’s), the Act provides for the following:
- A coronavirus impacted IRA owner (or spouse of an impacted owner) can take a coronavirus related distribution (CVD) from an IRA on a tax-favored basis.
- The distribution can be up to $100,000 with the ability to recontribute the distributed dollars back into the IRA within three years and have no federal income tax consequences (if you do not recontribute, you will be taxed on the distribution)
- Another benefit - if you are under 59 ½ the 10% early withdrawal penalty does not apply to a CVD (if you do not pay it back, you are subject to ordinary income tax but not the 10% early withdrawal penalty).
- See the Fiduciary Corner article in this issue for the definition of who qualifies as impacted by coronavirus. It is a pretty flexible qualification.
Withdrawal Rates in Retirement
For soon-to-be or already retired clients, their withdrawal rate is key to their money lasting in retirement. The general rule of thumb is 4% of your portfolio is a safe withdrawal rate with a 60%/40% equity/bond mix. Studies show this has a 90 to 95% chance of lasting 25 years. The recent market drop has changed that outlook for some. We recommend reviewing your asset allocations and withdrawal rates. If you liquidate assets that have dropped in value to meet your distribution needs, you “lock in” the loss without being able to make it up and it is a clear signal that you need to review your allocations. A few tips to get through this without having to invade your principal, allowing your portfolio some time to recover:
- delay Required Minimum Distributions (RMD’s) until year end if you can
- if you meet the flexible definition of “impacted by coronavirus” covered in the Fiduciary Corner article you may qualify to suspend your RMD for 2020
- look to spend cash reserves to delay selling assets for withdrawals
- reduce expenses or delay big ticket items (while this does not help the national economy, it most definitely helps your finances)
401(k)/403(b)/457 Plan (workplace retirement plans) Opportunities
A couple of thoughts for those contributing to a retirement plan at work and how you can navigate the current environment:
- for those nearing retirement, review your asset allocation and risk tolerance with your advisor – adjust as necessary
- for those early in their careers, this is great time to start or increase your contributions – you will buy more shares at the currently lower prices and accumulating shares is the most important thing you can do to build balances
- for some whose careers are furloughed or on hold, or have reduced hours, you may want to lower your contribution to equal the match percentage and save the remaining amount in your cash reserve
Please contact us if the recent virus-influenced markets prompt any discussions you would like to have. If you do not have an estate plan in place and would like a referral, we can facilitate that. For those clients who think their children may benefit from some of these topics, they should contact us as well.
OPA NEWS & COMMUNITY EVENTS
OPA & Another Covid-19 Perspective:
Normally this space is filled with the event calendars for a variety of the non-profit cultural organizations that we as a firm, our employees, clients or colleagues are involved with. It’s through these events, annual or otherwise, that they further their fundraising efforts and support the ongoing delivery of their missions.
Especially in these challenging times, their presence enhances the fabric of our community and the canceling of their events, as one can imagine, has become an extremely difficult financial reality to navigate. As noted above, we will get to the other side of this, but in the interim, if you have the means to help sustain any of your favored non-profits, consider that act as an investment that pays-it-forward on the quality and strength of our community once we get through this.
And although most industries have been adversely impacted by the closures required as we combat this public health battle, we should consider the hospitality and tourism related businesses that have been foundational in many areas of the country, but especially here in Maine. From restaurants to farmers, fishermen and lobstermen to breweries, wineries and distilleries, they all have seen a dramatic slowdown in their businesses, which has then resulted in a large number of people losing their jobs – something which we hope is only temporary.
To help them persevere through this, and to the extent you have the capacity to help, consider ordering takeout from your favorite restaurants offering the service, do curbside pickup and online purchases from your seafood provider and take advantage of the products you can pick up outside your local farmer, brewer, vintner or distiller’s place of business.
Just remember that we’re all in this together and anything we can do will be appreciated.