Panicking: Bad For Health & Deadly for Wealth.

“The nine most terrifying words in the English language are: I’m from the government, and I’m here to help” – President Ronald Reagan

We are writing on Monday night March 23, 2020 and Congress was in session all day negotiating a package that commentators are claiming needs to pass for the economy to survive the virus shock.  Apparently negotiations which were virtually agreed to Sunday night have been fractured by nothing less than partisan politics. We are at a TARP moment much like the Autumn of 2008. On first proposal, the House failed to approve TARP (which eventually became the backbone of the financial bailout).  The market promptly punished them, and several days later an amended TARP proposal passed.  The Fed, however, has moved forward with extraordinary measures intended to curb the panic including an agreement to buy corporate bonds. As an editorial comment, we believe the Fed is acting vigilantly and appropriately.  Their behavior appears apolitical. 

The stock market suffered another nasty drawdown last week and joining the carnage was most any security linked to credit.  Particularly weak were corporate bonds, municipal bonds and preferred securities. We hope you are asking how could bond prices be collapsing as interest rates on treasuries are trading at historical lows?  And didn’t the Fed just reduce overnight lending rates to zero?  

Bonds are simply legal obligations from the borrower to pay periodic interest payments and repayment of the full amount borrowed at an agreed upon date to the lender.  The lender can hold the bond to maturity, or they can sell the obligation to another party.  Last week a battalion of bond owners decided they no longer wanted to hold the loan.  Some because the virus had them panicked. Some because they noticed prices dropping and sold because others were selling.  And then there were owners who needed cash. Our belief is that much of the selling was of the third type.  However, they were selling into a market with no buyers, so buyers agreed to buy the bonds at dramatically reduced prices.

Stock positions are off 30% plus as of this writing, and corporate bonds are off 10% plus this month. Commodity prices have suffered comparable plunges.  Perhaps nothing has fallen harder than energy, which we discussed two weeks ago, with a collapse of crude prices now in the 20’s.  We would argue that much of the carnage is a function of margin calls. Investors don’t sell what they want, they sell what they can. This often explains the price declines in healthy securities.  With interest rates hovering at historical lows over the past few years, funds have used leverage to amplify returns. This works great in a good market.  It becomes a disaster during a crash.  We have no idea if the margin selling is over.  We do know that if buyers remain on strike, and sellers re-emerge with the need to sell, dealers will offer them diminished pricing.

Perhaps this sounds scarier than it should.  For bond holders the only thing that is important today is whether they will continue to receive their interest payments on schedule and their money back at maturity.  We would argue that the sell-off in bonds has been somewhat indiscriminate and not an accurate depiction of value.  In our opinion, the sell-off has created compelling opportunities in bonds, assuming the US economy is not on the eve of the next Great Depression.  

 We believe a critical component of thoughtful investing is developing a picture of the economy, business and the country a year or two from now.  Trying to articulate or alter an investment plan based on what might happen over the next few days or weeks is futile. We’ve stated our belief that panic in the markets will subside after the panic in the virus eases.  In due time we will have both a prevention and a cure.  At some point the path of the disease turns and we return to a more normal lifestyle.  Take trillions of Fed Reserve easing and several trillions of fiscal stimulus and add consensus adoption of social distancing for a while, and we will most likely survive the storm.  If so, the economy re-gains a footing, folks return to work, commerce comes back to life and markets start to perform rationally.

But we know you still may want someone to tell you what will happen today and tomorrow.  We don’t know what happens tomorrow.  But we do know what makes sense today.  Leverage and margin are double edged swords.  They’re great when markets move your direction and lead to potential insolvency when it doesn’t.

The business of news is dependent on the business of selling advertising.  Corrections of 40% or more for stocks have occurred five times over the past fifty years.  This won’t be the last time.  Your asset allocation should represent your tolerance for risk.  If you are taking income from your account, now is a time to consider taking less.  Long term investing means long term.  Panicking is bad for your health and deadly for your wealth.  In our opinion, investors willing to bare risk at this moment will be well compensated.