After setting all-time high levels last month, stocks began to reverse course mid-February as coronavirus fears took hold. Below please find our viewpoints, guidance and expectations.
A Moment to Reminisce
Even typing the date “March 9th” brings back memories from when I typed a similar letter on March 9th, 2009, the low point for stock markets after the financial crisis of 2008. The market concluded a 17-month stock market drop of over 56% in March of 2009. The S&P 500 index traded at a level below 700 that week. Once the dust settled, and investors realized the world would indeed not come to an end, the longest bull market and economic expansion in history commenced.
As difficult as this experience was, being an asset manager during this time period helps me put some context around the current market stress. By remaining calm, level-headed and focused on the reality presented by the data instead of the fear forced on us by news headlines, some of the most profitable investment themes in my career were possible due to the 2008-2009 dislocation in the markets. I have no doubt the current situation will reveal similar investment opportunities; however, we are not there yet. Patience, resolve, confidence in your financial plan and investment process is crucial as this correction develops.
Worldwide central banks are moving quickly to provide liquidity for businesses and consumers. These measures will help, however, simple rate reductions are likely to have limited benefits going forward. Policy makers are already beginning to discuss ways to lessen the negative economic impact this situation could foster. Look for governments to begin proposing fiscal policy stimulus plans like tax cuts, government spending increases and corporate incentives in the coming weeks. The financial crisis of 2008 is still very fresh in the minds of policy makers and will likely lead to a steady stream of assistance from governmental bodies worldwide.
Disruption Spurs Innovation
A serious dislocation in supply chains and employee mobility forces businesses to become more efficient, accelerates research and development for suitable substitutes and alternative suppliers, and can lead to significant technological breakthroughs. We are already beginning to see some of these changes as companies rely on virtual work environments and video conferences to help reduce the risk of coronavirus infection. These coping strategies double to reduce costs such as travel and lease expense which coincides nicely in the face of potential revenue declines.
The strength of the consumer has been a bright spot for our economy. With a market correction and an emerging worldwide pandemic, some weakness is to be expected from consumers as they tighten budgets and postpone large discretionary spending. That being said, widespread layoffs are not expected as of this writing. Laying off employees is very disruptive to a business, and rehiring staff is a very expensive and uncertain proposition in such a tight labor market. Given what we know today, economic activity is not expected to deteriorate enough to warrant mass layoffs and rapidly increasing unemployment.
It is a safe bet volatility will continue through the spring as market participants attempt to match their expectations with reality. We are hopeful new coronavirus cases will begin to level off as temperatures rise this summer. As this happens, a more realistic picture of the economic impact will be visible to investors. As is typically the case, markets overreact and tend to price in the worst-case scenario. While we do believe corporate revenue and economic activity will be negatively impacted, there is good possibility markets are going to reach levels that in hindsight were too pessimistic. We are not there yet.
Since the fall of 2016, Merit equity positioning has been aggressive, favoring growth stocks given our optimism surrounding corporate earnings growth, the positive impact of inexpensive readily available credit and tax cuts.
Seeing valuations were stretched, and the global economy was slowing even before the coronavirus was revealed, our team began risk-reducing measures both in August of 2019 and February of 2020. The weighting to our most volatile investments were reduced, replaced with investments expected to capture less downside should markets decline from all-time high levels. These strategy changes lowered the downside capture target by 20% from previous levels which have helped in an attempt to limit losses. Liquidity in the bond markets remains our number one concern. Companies rely on the availability of credit to fund current operations. The knee-jerk reaction in bond markets has a tendency to immediately price in the worst-case scenario before gradually loosening up. Last week saw those fears manifest in significantly lower interest rates and some early signs liquidity is beginning to become an issue. Well-capitalized high-quality companies are not expected to be severely impacted given high cash balances and a long refinancing window. However, we are beginning to see the initial stages of illiquidity for lower quality and over levered companies. Look for our team to consider increasing the credit quality of our bond positions should liquidity continue to contract.
We expect to keep you informed on our latest thinking and portfolio recommendations on a weekly basis until further notice. We are grateful and humbled by the trust you have placed in your advisor and our investment team. As always, feel free to reach out to any of our team members should you have questions regarding our strategy or outlook.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Merit Financial Group, LLC, an SEC Registered Investment Advisor. Merit Financial Group, LLC, Merit and Merit Financial Advisors are separate entities from LPL Financial. Tracking Number: 1-962140
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to affect some of the strategies. Investing involves risks including possible loss of principal.