March 6, 2020
Making Cents of the Markets
Be In The Know
While it certainly didn’t feel like it, US markets actually closed slightly higher on the week thanks to big upward moves on Monday and Wednesday as well as a late rally Friday. The selloff the last two days was due to a spike of new coronavirus cases in the US, Singapore, and several European countries. While global cases reached 100,000 on Friday, growth of the virus outside China slowed to 17% (from 30%) and new cases in China have slowed to 0.2% as it appears that they have contained the virus. Recovery rates continue to increase as 55% of those infected have already recovered. There is a lot of misinformation on the virus, and even more poor analysis of the situation (especially on the mortality rate), even by mainstream media, which we believe has elevated fears more than justified. This is why it’s vital to review reliable sources and ensure that all facts are being considered. One good article that we feel explains it well is here: The flu has killed far more people than coronavirus. So why all the frenzy about COVID-19?
But why is the stock market so fearful of the virus? In a word – uncertainty. The market does not like uncertainty and the impact of the virus is still unknown. Combine that with some extreme theories and analysis and you get elevated fear. Fear that this flu will cause consumers to stop spending money, which will in turn cause profitability of companies to falter, which could then snowball into a recession. Yes, certain companies will see their profits dip at least temporarily but not all companies will be affected to the degree that the correction is indicating. Consider that even if the entire city of Vancouver was under quarantine, and the streets were deserted, you will still have to pay your phone bill and you will still have to pay your utility bill. These telecom and utility companies will see their profits stay much more stable than an airline or cruise line who sees their bookings drop drastically.
On the fiscal side of combating the impact of the virus, the US Federal Bank announced a surprise cut in the benchmark interest rate by 0.5% on Tuesday as they wanted to move pro-actively to support the US economy to help offset any near-term weakness in the global economy. The Bank of Canada followed suit on Wednesday with a 0.5% cut for the same reasons but this seemed overdue as they were one of the last developed global nations to drop rates lately. On top of this, the US government passed an $8.3 billion emergency spending package for prevention efforts and research to quickly produce a vaccine.
Despite the volatility and fear, economic data was quite positive this week with strong job gains in February in both the US and Canada that well surpassed expectations. Unemployment rates remain near decade lows as the US economy is in a stronger position than last time rates were decreased. Lower rates should provide interest savings for both consumers and corporations that should assist economic growth going forward. We realize that economic data is a lagging indicator but do not see any signs of a recession thus expect markets to find some support and head higher soon.
As our active management investment strategy dictates, we remain patient and defensive in this environment. We believe the situation will get better sooner than later as numerous countries are committing significant resources to contain the virus, treat it effectively, and come up with a solution. Our defensive positioning over the past few weeks includes higher than normal cash levels and healthy exposures to defensive areas of the market like utilities, telecoms, and healthcare. This patience has paid off thus far as many of our favourite companies are more attractively priced and thus our “buy list” has grown as more time has passed without a bounce. Given the uncertainty on the timing of the recovery, we are going to add some of this cash to fixed income investments to increase our diversification and help with returns moving forward.
Positioning has been crucial over the past month as the hardest hit sectors include energy, travel and hospitality, and mining. We are pleased to report that we have avoided companies within these sectors due to volatility and concerns around these sectors prior to the virus. Oil fell even lower to $41 per barrel and is down approximately 35% on the year which highlights the importance of risk management as many oil & gas stocks are down more than this. It is important to understand that if one is down 50% on a stock, they require 100% to breakeven as large losses are exponential in nature. This is why we are confident in our ability to manage risk in environments like today and then to take advantage when the dust settles.
Chart of the Week
We want to highlight how the recent surprise interest rate cut by the US Federal Reserve is different. The US Federal Reserve has only surprised the market with interest rate cuts eight times in history, but it is important to note that most of these instances occurred right before or during a recession. These were time periods where credit conditions where challenged and consumers and corporations alike had difficulty obtaining loans for various purposes. The chart below shows the relationship between interest rate decreases and credit conditions in the US since 1990:
Source – Manulife Asset Management
We note that today is a different situation in that the Fed pro-actively lowered rates as many other global banks were lowering rates to support the global economy thus the US wanted to do their part. The key difference to historic surprise cuts is that credit conditions remain healthy and the economy is on a solid footing with a strong housing market, consumer, and jobs market. Government bonds like treasuries have rallied this past month and gone exponential as investors have flocked to “safer” assets. Investors recent crowd behaviour suggests they believe a recession is coming soon yet there is no other evidence to support these claims. This is why we remain calm, cool, and collected as we wait for positive confirmation that markets have bottomed out and then will look to put our cash to work.
Beyond the Markets
Sunday, March 8th is International Women’s Day! In addition to celebrating and promoting the empowerment of women, the theme for 2020 is #EachforEqual, a notion which acknowledges the strides we continue to make in achieving gender equality but stresses that we still have a ways to go. Equality is essential for thriving communities and economies and the race is on to create a gender equal world. This cannot be accomplished in one day but no step forward is too small!
Take a look here at our latest article from Business in Vancouver’s Retirement Ready Magazine where we dive deeper into how to manage your emotions when investing.
Listen to our latest Making Cents of the Markets segment on CKNW. We gave listeners an update on the markets, coronavirus, and interest rates. Listen here.
Take a look here at our most recent North Shore News article where we discuss the qualities you should look for in a “super star” financial advisor!