by Shawn Narancich, CFA
Executive Vice President of Research
Battle Engaged, Not Yet Won
First and foremost, we want to extend our concern and empathy to those whose health has been directly impacted by the virus, as well to those in the travel, entertainment and restaurant industries whose jobs are increasingly at risk. Amid accelerating efforts to “flatten the curve” of COVID-19 infection rates, an exhausting week of financial market chaos has finally ended, if not so mercifully. The benchmark S&P 500 declined another 15 percent this week and is now down a staggering 32 percent from highs reached just one month ago. As portrayed in the chart below, blue chip stocks’ descent into bear market territory is unprecedented in its velocity.
Source: Strategas
Shock & Awe
As reported U.S. infection accelerates, the Fed has gone all-in to ensure that a public health crisis does not turn into a financial crisis. At our central bank, what’s old is new again: zero interest rate Fed Funds, hundreds of billions of dollars’ worth of new quantitative easing (QE) and lending support for money market mutual funds. These actions harken back to programs in place during the Great Financial Crisis twelve years ago. As well, the Fed has announced a new commercial paper funding facility that will have our central bank directly buying short-term IOUs from corporate America. The common denominator? Helping reduce the cost to finance businesses during a time of increasingly unprecedented demand shock while ensuring the integrity of the banking system and capital markets. In short, the Fed is taking bold action to backstop the financial plumbing of the U.S. economy by becoming its lender of last resort. Fiscal policy is becoming increasingly hands-on as well; next week, we expect to hear more about what could be a $1-2 trillion stimulus package currently working its way through Congress.
Light at End of the Tunnel
For investors holding stocks amid the carnage, there is hope — as the old saying goes, investors stop panicking when central banks and governments start panicking. As importantly, we realize that the U.S. economy is being artificially repressed to combat the virus, which means that when we win the battle against it, people will go back to work, economic activity will rebound and stocks will bounce back. Entering the pandemic, U.S. unemployment stood at a 50-year low, wage growth was above inflation and consumer confidence was high.
Air Pocket
In the meantime, the U.S. economy will almost assuredly recess. But as the chart below shows, the same U.S. consumption that is being hit hard today as Americans self-isolate will be the fuel for a sharp rebound in the economy afterward.
Source: Goldman Sachs
Fiscal and monetary stimulus being applied today should serve to accentuate the rebound.
No Time to Sell
Recognizing the increasingly attractive valuation of equities and the high valuation of bonds that have offered effective ballast to portfolios amid the swoon in stocks, our next asset allocation move will be to reduce bond exposure and add to equities. Two of the three key inputs to implementing this decision are in place — increasingly compelling valuation and negative sentiment. Once infection rates peak, we expect to take action to rebalance accounts that have become overweight bonds. In the meantime, we advise clients to sit tight with the equities they have while weighting the investment of any new cash to stocks. Ultimately, while we can’t control a Black Swan event like the virus, we can control our reactions to it.
Our Takeaways from the Week
Stocks sunk further into a bear market amid increasing central bank and government action to combat the virus pandemic
Our next move will be to sell bonds and buy stocks