The Corona Crash and Market Prospects
The Corona Crash started with the recognition that the U.S. and global economies would need to fully or partially shut down as a result of the Coronavirus. Attachment 1 lists the chronology of the spread of the Coronavirus. Between February 21 and March 23, the Dow Jones Index declined over 10,000 points, representing a 34% decline in value. Between March 15 and 31, the Federal Reserve deployed a remarkable sequence of policies, listed in Attachment 2, followed by action from Congress and the President, to stabilize the markets. Stocks bottomed on March 23rd and rebounded quickly. The financial markets continued to improve, resulting in approximately a 50% recovery of the market crash.
It is too early to tell if the stock market has bottomed. But my sense is that the markets have largely priced in a very grim 2020 and we are trading based upon expectations for 2021. The impact of announced fiscal and monetary stimulus is astonishing and should hopefully create a path out of the recession. As a result of monetary and fiscal stimulus, growth could resume in early 2021. My best guess is that another round of stock selling could still be in front of us this summer but that it could lead to an interesting buying opportunity.
Figure 1 – Dow Jones Index Has Recovered 50% of its Decline
The Bond Market Collapse and Recovery
Normally, when stocks go down in price, high quality bonds go up in value. Not in the Corona Crash. The chart below displays a 1 month stretch when everything went wrong for bonds, partially caused by:
- Oil industry bonds were downgraded due to supply shocks, many to junk status.
- Many corporate bonds, particularly of highly leveraged companies and consumer facing industries, declined precipitously.
- When U.S. Treasury interest rates approached zero, money market fund assets became suspect.
- ETF’s lost their market makers and liquidity. Trading gates were discussed.
Figure 2 – The Collapse and Recovery of Single A-rated 3 yr. Corporate Bond ETF
The U.S. Federal Reserve Saves the Day!
As the Corona Crisis unfolded, Fed Chairman Powell announced that the Fed would act appropriately to provide liquidity to the system (Feb 28) followed by lowering interest rates: first by 50 bp (March 3) and then by 100 bp (March 15). This was clearly not enough to stem the demand for liquidity. Over the period from March 16-March 30, the Federal Reserve created or made at least 15 policy changes to liquify the economy. The list of actions was so long I added it as Attachment 2 in this report. Stunningly, the Federal Reserve has even backstopped municipal governments and the congressionally approved SBA loan programs. The sum of these actions has moved substantial amounts of liquidity and credit risk from the banking system to the Federal Reserve.
Get Ready for an 80% Economy
I am optimistic that the economy will be on the road to reopening by June, followed by some starts and stops over the summer. Social spacing, face masks and general wariness will be central to finding a “new normal” social solution. However, with over 20 million newly unemployed people, it may take at least into 2021 before the economy fully recovers. After a 10-year economic recovery, a recession lasting 12-18 months would be considered normal. Companies and industries are more likely to reinvest and restructure themselves in down cycles, resulting in greater pain for a short period of time. In my opinion, the economy is likely to operate at 80% of capacity for the balance of the year and then show meaningful improvement in 2021. Our goal is to come out of this recession fully invested in funds, ETF’s and industries that will be the new leaders for the next economic cycle.
New Trends and Investment Themes Coming out of the Corona Crisis
The Corona Crisis has changed our way of life and will result in new stock market winners and losers. Industries and companies will reinvest themselves. Themes we expect to hear more of include:
- The internet of everything – Use of the internet after the crisis will not go back to pre-Corona usage. Usage will be higher than ever for business meetings, social media, shopping, business, entertainment, healthcare, legal/accounting, gambling, sports, and many other functions and services. Companies will be evaluated based upon the quality of their online experience.
- Focus on Millennials – The big winners during the next ten years coming out of this panic are the millennials. They don’t own much in common stocks. Many millennials are bearing children and want to buy a new house, drive a minivan and shop at Target. Historically low mortgage rates will help them find their consumer nirvana. Millennial facing companies should succeed.
- Increased home ownership – The U.S. is massively understocked with new homes, because single millennials crowded into tech-based, expensive cities. Thanks to the coronavirus, they found out that cities have a downside and everyone who can work from home has been doing it. Mass intra-country migration should spread people into less crowded and significantly less expensive cities when this dawns on everyone. We like homebuilder stocks.
- Increased demand for healthcare – The coronavirus will expose the demand for universal healthcare. The current insurance system has been widely exposed as unfair and unwieldy. Stories of $1,000 Emergency Room visits, the unwieldy co-pay system and divergences of coverage are frequent. People are likely to accept a broader social need for basic healthcare. Healthcare spending is likely to rise and many providers will benefit.
- The U.S. Banks have been backstopped by the Federal Reserve – The banks have received limited immunity from credit defaults and are likely to make money under the Corona Stimulus packages. Financial stocks should be leaders when the economy recovers.
- Over-leveraged companies may go bust – Many companies whose prospects were once favorable have been turned upside down by the coronavirus and need big financial packages to just make it to the other side of the recession. Companies with a strong balance sheet will have a better chance of making it out of the recession. Active mutual funds are more able to screen for strong balance sheets than index-based ETF’s.
- Many previous safe investments are now suspect – Dormitory bonds; Hospital bonds; Restaurant stocks; College tuition rates in an online world; Cruise ships; Stadiums are all suspect investments. Bonds and stocks that support these businesses could suffer. This is another reason for owning mutual funds vs. ETF’s when coming out of a recession.
- How much federal debt is enough? – As the Federal Reserve moved to QE infinity and the federal government deficit grows to 12% to 15% of GDP, the credibility of U.S. debt may become suspect. Politicians are not good at such choices and the public does not yet care. At some point, the bond markets are likely to react to a glut of global government debt and charge higher real rates of interest. We are already seeing increased demand for assets that preserve purchasing power such as gold and bitcoin. If timed well, real estate may also become a good long-term source of value.
Figure 3 – The Dow Jones Industrial Index: 2010 to 2020
Stock Market Tactics
As displayed in Figure 3 above, the market’s upside should be contained by DJI 25,500. Downside support starts at 21,000 with even stronger support at 17-18,000. Since the Federal Reserve has added tremendous liquidity and removed sources of credit risk from the system, the investment markets are likely to focus on the speed of recovery and prospects for 2021. While we expect many starts and stops ahead of us, we are looking for opportunities to get more invested in the winners of tomorrow. As of now, new leadership is unclear. My best guess is that another round of stock selling could still be in front of us this summer but that it could lead to an interesting buying opportunity. The goal is to come out of this recession fully invested in funds, ETF’s and industries that will be the new leaders for the next economic cycle.
Scott P. Noyes, CFA CFP®, is the President of Noyes Capital Management®, LLC, an independent fee-only wealth management firm based in New Vernon, New Jersey. Please visit our website at www.noyescapital.com
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Attachment 1 – Timeline of the Global Spread of the Corona Virus
Jan 7 – China publicly announces the discovery of a new virus
Jan 11 – China records its first death
Jan 20 – First case of Corona reported in the US, Japan and South Korea
Jan 23 – Wuhan quarantine starts
Jan 25 – First Corona cases in Singapore and France
Jan 27 – First Corona cases in UK and Italy
Jan 30 – WHO declares global health emergency
Jan 31 – President Trump restricts travel from China
Feb 14 – France announces first Corona death in Europe
Feb 23 – Italy sees major surge in cases & locks down several towns
Feb 24 – Trump asks for $1.25 B in corona response; Congress gives $8 billion
Feb 24 – Iran emerges as a Corona problem
Feb 29 – US records first death in U.S.
March 3 – US approves widespread testing as CDC test failed
March 3 – Spain Corona outbreak escalates
March 11 – WHO declares a pandemic
March 11 – President Trump restricts travel from Europe
March 13 – U.S. National emergency declared
March 17 – France declares nationwide lockdown
March 19 – NY State quarantine
March 23 – NYC confirms 21,000 cases
March 23 – Great Britain locked down
March 24 – India announces 21-day lockdown
March 26 – U.S. leads world in 82,000 confirmed cases
March 28 – NY, NJ, CT announce 2-week non-essential travel bans
March 30 – more states announce travel bans
April 2 – The world passes 1 million confirmed cases
April 7 – 95% of U.S. is under lockdown
April 8 – Wuhan province ends travel quarantine after 78 days
April 14 – The world passes 2 million confirmed cases
Attachment 2 – Partial Listing of Federal Reserve Actions in response to Coronavirus
March 3 – Reduced interest rates 50 bp.
March 15 – Reduced rates 100 bp and launched a $700 billion round of Quantitative Easing.
March 17 – Fed and FDIC loosened limitations on bank lending allowing them to use liquidity buffers for lending.
March 18 – Money Market Liquidity Facility (MFLF) – no recourse loan to money market funds. Take bad bonds off their books.
March 18 – Primary Dealer Credit Facility was expanded to include all sorts of asset-backed securities, commercial paper, corporate securities and municipal debt.
March 18 – Commercial Paper Funding Facility was brought back.
March 18 – Allowed banks to run daylight overdrafts – collateral not needed.
March 18 – Reduced bank reserve requirements to zero.
March 20 – MFLF expanded to include municipal debt with a maturity of 1 year or less.
March 20 – Chairman Jerome Powell of the U.S. Federal Reserve stated in a speech that they would provide all the liquidity necessary to keep the market going.
March 23 – The Term Asset-Backed Securities Loan Facility (TALF) was brought back and expanded. Originally, TALF accepted the underlying credit exposures of eligible ABS with collateral from auto loans, student loans, credit card loans, or small business loans guaranteed by the U.S. Small Business Administration. Coronavirus’s TALF added Auto loans and leases; Student loans; Credit card receivables (both consumer and corporate); Equipment loans; Floorplan loans; Insurance premium finance loans; certain small business loans guaranteed by the SBA; and, eligible servicing advance receivables. Finally, these loans are non-recourse, if the security defaults, the Federal Reserve cannot go after the owner.
March 23 – Added Bank CD’s and Commercial paper to MFLF.
March 24 – Encouraged banks to “work with” debtors who can’t make payments. Specifically, loan modifications during Coronavirus will not be treated as “troubled debt restructurings”. This freed up bank reserves on their balance sheets.
March 27 – Congress and President Trump approve $2.2 Federal Stimulus bill.
March 20 and 31 – Expanded central bank swap facilities to a lower tier of central banks. In this facility the Federal Reserve would make a standing offer to temporarily purchase U.S. treasury securities from central banks (and supranational monetary institutions) and sell them back to them the following day. The purpose is to help foreign central banks get cash instead of selling US treasuries.
April 6 & 9 – Fed announced Main Street Lending Programs. To implement the relief provided by the CARES Act and support the work of Treasury and the Small Business Administration (SBA), the Fed:
- Announced a new emergency lending facility, the Paycheck Protection Program Liquidity Facility (PPPFL), that will purchase Payment Protection Program (PPP) loans from lenders, freeing those banks to continue lending under the PPP, and most crucially, removing these non-performing loans from the balance sheets of private industry;
- Announced a new emergency lending facility, the Main Street Business Lending Program, that will purchase $600 billion of debt from companies employing up to 10,000 workers or with revenues of less than $2.5 billion, with any required payments on these loans deferred a year;
- Announced a new emergency lending facility, the Municipal Liquidity Facility, that will purchase $500 billion of debt from states and cities with populations over 1 million; and
- Expanded the scope of three existing facilities, the PMCCF, CMCCF, and TALF. These programs will now support up to $850 billion in credit. In addition, the Fed has expanded the list of eligible assets for participation in the TALF program.