“Be fearful when others are greedy and greedy only when others are fearful” – Warren Buffet.
We’re writing to offer our perspective on the economy and a March Madness without players. And if you own stocks, you may be expecting an answer to the question most likely on your mind, “How much lower can it go?” The brutally honest response is that we don’t know, and despite many claims to the contrary, nobody else does either. It’s a question without an answer – only guesses.
In December and January we read or listened with mild interest, the prognostications of the brightest in our industry. Most were optimistic about 2020. Generally citing economic stats, financial engineering, and world trade as raison d’etre for rising stock prices. The experts also cautioned with the usual cast of caveats. You know them – inflation, trade wars, populism, negative interest rates, Brexit, Iran, war, and so on. Nowhere on that list will you find Coronavirus or $30 oil.
The U.S Equity Market declined nearly 30% in 16 days. For math folks, that equals about $11.5 trillion. Perhaps by the time you read this, the entire market gain of the Trump Era will have been erased! This is not an editorial, only an observation. We find the decline remarkable considering interest rates in the U.S reaching historical lows, while employment rates reach all-time highs, plunging oil prices and exploding corporate earnings. It’s never been a better time to be a borrower. If you own real estate, you have a profit. If you own bonds, you have a profit. And just three weeks ago, the same could have been said of equities.
We won’t bore you with a recital of Coronavirus stats. You’ve read them. You’ve heard them. And perhaps, like us, you wonder why this new named pandemic might lead to a more malignant outcome than Legionnaires disease, Mad Cow disease, Swine flu, or the Bird flu! As of this moment, we’ve lost 80 plus Americans to the virus, many from nursing homes in Seattle. This is not to minimize the seriousness of the virus or the loss of life it has caused, but simply for perspective. A friend texted us this morning with the following question, “What about this Coronavirus?”. We responded, “We don’t want to catch it!”. “No, I mean in reference to the market?”, he asks. Our response – “The answer remains!”
Several weeks ago, the Federal government communicated a message leading a listener to believe Americans had little reason to be worried. Last night, the message morphed. Panic in the markets now mirrors panic over the pandemic! The authorities are canceling well, everything. We are essentially quarantined and maybe that’s okay for a moment. The skeptic in us surmises cancellations reflect concern for being sued as much as concern for health. But when you have the NCAA, Major League baseball, public officials, and government spokesmen pulling the plug, why be a skeptic?
The probable truth is that like most things, the Coronavirus will pass. The summer heat might kill it and “social distancing” might just hamper it’s spread. We’re not convinced we aren’t overreacting, but we’d also be just fine with successful prevention looking like an overreaction. We should all agree that the crisis will subside, or it won’t. If you believe we will get healthy again, read on!
There is no doubt that the Coronavirus crisis will penalize the U.S economy. From what we’re reading and hearing, it is likely we will suffer through at least a short period of diminished business activity where both revenue and earnings will surely decline. If the market is an accurate discounting mechanism, current stock prices might predict a 30% reduction. Certain industries will be beneficiaries. Most won’t. Could the market recover to post a flat 2020? Possibly. But only if the paralysis is short lived. The longer quarantines, cancellations, and social distancing persists, the greater the probability companies begin to fail, unemployment rises, and bonds default. This could be a vicious spiral and if so, the market might not be fully discounting the change.
You may have noticed government debt is trading at levels never witnessed in this country. 10-year treasury bonds yield less than 1% and 30-year treasuries yield slightly greater than 1%. The bad news is this low yield reflects a flight to safety. The good news is the U.S government is capable of financing measures to mitigate economic damage without inflicting significant stress on our current deficit (which is predicted to be well above 1 trillion this fiscal year). Ironically, the corporate bond market is experiencing higher financing rates.
Energy is one sector experiencing stress. Due to a love spat between OPEC and Russia, oil prices have plunged to $30 plus a barrel. At this level, many U.S energy companies can’t make money as their production costs exceed, and for many companies, vastly exceed $30. Energy stock prices have been butchered, as have their bond prices. We would be remiss to just look to the virus as the fly in the ointment. Some $80 billion in energy bonds mature this year. Without a significant crude price hike, some will default. We would argue that we should be concerned, not panicked. Pundits have declared oil dead before, and as alternatives gain a footing, its decline might in fact one day be fatal. But not today!
Although this waterfall decline has not been labeled a crash, let’s at least call it a crush. We don’t believe we have a financial issue like 2008. We have a crisis in confidence much like 2001. The world was paralyzed for a period after 9/11. Business and economic activity declined, a mild recession followed, accompanied by a bear market that fully recovered in time. For the seasoned investor, great companies were on sale much as they are today. A few weeks ago, we would have argued the volatility in the market was just computers trading with other computers. This week we’ve seen margin selling. The final down thrust typically includes panic selling, which for those engaged, is often comfortable but seldom sane. The madness of crowds provokes anxiety.
We think you can expect some positives which we hope you don’t mind us listing:
- The Federal Reserve could continue to marginally cut short term lending rates, which could produce liquidity if markets require, and may very well recharge quantitative easing.
- The government could approve stimulus plans aimed at putting more money in your hands. It might come in the form of tax cuts, tax holidays, one-time stipends, and backstops for small business.
- Corporate leaders could begin the process of trying to reassure with repurchase announcements.
- The virus could reach an inflection point after which new cases and deaths decline.
- Major League Baseball could resume its schedule.
Tough times don’t last. Tough people do! We’re glued to the news on the virus. Most focus on worst case scenarios and admittedly, they are scary. Seldom are best case scenarios considered. However, we do think it’s fair to balance the possible outcomes in the middle. We won’t argue it’s not serious, it’s just not the plague. Ask again what we think of the Corona virus. “We don’t want to catch it!”
Regardless of current conditions and/or quarantines, we’re available if you need us. Just email or call.
The Berkeley Capital Partners Team