Recovery Perspectives

As cities and states in the US begin relaxing pandemic restrictions, many investors remain concerned about the markets, skeptical of its quick recovery in spite of what still seems like a large amount of uncertainty as to how this “reopening” will ultimately play out. Admittedly, many questions remain about the shape of recovery, the long-term impact of bankruptcies, the long-term consequences of the government stimulus efforts, the possibility for a “second wave”, and rising unemployment resulting in a second Great Depression.

Recovery Timing

In our view, the Dow’s recovery from the low on March 23rd indicates an expectation by the market that the economy will ultimately recover and while some businesses may not survive, many more of them will. Most of the Q2 forecasts we are seeing are incredibly negative with respect to economic figures, but with meaningful recoveries beginning even before we get to the end of the quarter. Furthermore, the economy is expected to build momentum in the second half of this year and into 2021. We believe this is the most likely outcome and that we will not have to wait until 2021 for significant progress to be made.

Bankruptcy Concerns

Like many, we wonder what impact the rising numbers of bankruptcies could have on the banking system. Fortunately, banks are in a much stronger position now than they were in 2008. They have larger amounts of reserves now, and as such are better able to absorb loan defaults from bankruptcies. While the Small Business Administration made capital available to small businesses through the CARES Act/PPP, the Fed has also taken measures to help provide access to capital for companies that need it and by direct involvement in the distressed debt market. One example of this was that Boeing was within days of accepting a government bailout. But when the Fed intervened in the high yield bond market, access to liquidity returned and Boeing was able to raise $25 billion just a few weeks ago eliminating their need for government assistance.

Government Stimulus Implications

In our opinion, one of the more serious challenges is the long-term impact of the government stimulus. We do not believe this is a near term issue. US government bond rates are incredibly low right now (0.72% on the 10-year bond as the time of this writing). If there were an immediate risk of higher inflation or a concern that the US cannot fund this higher level of debt, then rates would be much higher. However, we are concerned about this longer-term – for our children and grandchildren. If government spending is not reigned in quickly after this virus has passed, the next generations could be fighting a strong headwind.

“Second-wave” Worries

As for a resurgence of the virus, it is possible, but not certain. Expectations are for some level of increase in new cases as states reopen allowing workers to return to work. However, we believe it will be manageable and monitored closely. Many states that have reopened are reporting less-than-feared surges. Additionally, the pharmaceutical interventions, both treatments and vaccines, are being developed quicker than ever and with an unprecedented level of global collaboration. In just 90 days tremendous progress has been made and a major breakthrough could be announced at any time that would be a complete game-changer.

A Second Great Depression

Despite the significant surge in unemployment, something comparable to the Great Depression is not an expectation shared by most economists. Economic historians describe the Great Depression as a 10-year experience. Even those projecting a slower recovery from this recession are not expecting anything near that duration. It is also important to remember that the Federal Reserve had only been created in late 1913 and monetary policy tools were not as well developed by 1929 as they are now. The Great Depression was much more severe than it had to be because of missteps by a new Fed. Now, the Fed has a more well-developed understanding of the economy and how their actions impact it. On top of that, the stimulus packages that have been passed have added fiscal policy assistance to this challenge.

Summary

The near-term future certainly qualifies as “uncertain”, which is when stock markets typically demonstrate the volatility for which they are most famous. Volatility, though, is no stranger to a long-term investor, and this is the reason we structure our client’s portfolios with a full complement of bonds and alternatives. In periods of stock market volatility, these provide both stability and a source of funds we can use to buy stocks on weakness so that your portfolio can recover even more quickly.

As of yesterday’s close, the S&P 500 is down 9% year-to-date, which is well within normal ranges and we are encouraged by how well the combination of diversification, discipline, rebalancing, and tax-loss harvesting have served our clients. We don’t know what the near-term future holds, but we remain committed to the long-term investing tenets which we believe improve the odds of seeing clients achieve their stated goals.