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Special Market Update

March 16, 2020

US markets had another rough day as the fallout from COVID-19 continues, so I wanted to get in touch with you ahead of our regular Digest update on Thursday.

I’ve been in constant contact with my Profitable Investing subscribers during the selloff, and I want to share my thoughts with you today as well.

Read on for the issues I’m seeing in the markets, potential solutions and what I’m watching to determine when the worst of the selloff will be over.

Here’s what I wrote to my subscribers earlier today…

More to Go

The US is four weeks into the fallout from the COVID-19 outbreaks. And the S&P 500 Index continues to reflect concerns over the impacts from reduced demand for goods and services resulting in lower sales.

S&P 500 Index—Source: Bloomberg Finance L.P.

China went through roughly two months of major economic and market fallout before getting back to work and having their markets begin to reflect the recovery.

The US is much more decentralized than China, so the process of getting past the business and consumer impacts from the virus is at least going to take as long and may well last longer. This means getting back to work on a more normal basis will take at least four more weeks.

Fed Action

To provide offsets and assistance to recovery, we’ve had two major announcements from the Federal Reserve. Last week, it provided more liquidity for financials and others in the markets by ramping up credit in the repurchase agreement (repo) markets as well as boosting its bond buying.

On Sunday evening, it cut its target rate for Fed Funds (the rate that banks charge each other and guides market deposit and loan rates) to 0.25%, a 1.00% (100 basis points) cut.

This will make the credit markets much more affordable and will aid both banks and their debtors as well as alt-financials, which lend and hold privately placed corporate loans, including collateralized loan obligations (CLOs).

In addition, the Fed also announced a further $700 billion in bond buying, which will aid the credit markets.

There are many other behind the scenes actions that the Fed is doing. But one thing that’s missing is buying in the corporate bond market. I’m watching for some kind of action here, which would go over very well.

The underlying trouble facing the stock market is that we can’t accurately value stocks based on sales and earnings.

But we can look at underlying asset values and net book values. And so the key argument to make when making the call to continue to own each stock in your portfolio as well as in the model portfolios is what the underlying companies’ book values really are relative to their stock prices.

Then you need to examine each company’s ability to service their debts. This is why I always look at the credit of each company behind their stock and why I continually note their debts and their cash and other assets in terms of their ability to sustain themselves.

The Fed knows this as well, and that’s why its actions are so important in helping out banks as well as the rest of the companies in the US.

Legislative Action

Meanwhile, we’re waiting for the US Senate to pass the initial economic assistance legislation that was put together by the Administration and House leadership.

Congress has to re-vote on the measure to fix some missed glitches before the president signs it. This will bring some help to Main Street.

The president also invoked the Stafford Act and is sending federal aid to states as well. But the economy and the stock market still need more shots in the arm. Hopefully we’ll see new measures in the coming days and weeks.

The initial actions by the Fed and Congress are both good, but for now the stock market is rightfully still concerned with the quickly shifting circumstances. It will take some weeks to get through this, as it did in China and other first wave Asian nations.

What I’m Watching

There continues to be real data on COVID-19 coming out, particularly from Chinese and South Korean health agencies.

The data shows that the vast number of infected have mild to no symptoms. And by age group, the deaths are nearly zero for those under 60 years of age. Chronic respiratory ills had a direct impact on 60+ age group deaths.

But the news will continue to focus on the virus spread, testing and closures of restaurants, stores and companies. This will make for further troubles for stock prices.

In the March issue of Profitable Investing, I presented various indicators, including the New ConTex shipping index.

The turn in this index and other indicators will be a strong indicator that the economic impact of COVID-19 is passing.

Container Ship Time Charter Assessment Index (New ConTex)—Source: Bloomberg Finance L.P.

And as companies begin to make announcements of re-opening, that will be swiftly reflected in stock prices in general.

Meanwhile, the bigger dividend, US-centric companies with ample assets and debt service ability will continue to hold their values better.

That’s why our model portfolios are well stocked with utilities and real estate investment trusts (REITs). And bonds and bond-like investments including funds are doing their thing with cash payments and better values.

Going into this mess, the allocation of 56% stocks and 44% fixed income (with 11% of that in cash) was the way to defend against some of the meltdown in the stock market.

As I work on the April issue, I plan to go through the underlying asset values of each of the holdings and their credit profiles. If any of the holdings don’t stack up, we’ll say farewell.

Now, check out what I wrote last Friday to see how the selloff stocks could resolve itself in the coming months and years…

Getting Through This

Every market correction is different.

The latest selloff in US stocks has been gut-wrenching, largely because it has come from rising uncertainty regarding the impacts of COVID-19 on the US economy and the underlying companies.

During the past few weeks, markets have been selling stocks for a worst-case scenario rather than more likely scenarios. This is understandable since details are sketchy and this issue is slowly developing.

The bottom line is that the virus and its near-term effects will mean that consumers will be spending less, companies will sell less and earnings will be lower. We have limited hard data since nearly all current data on the economy and companies is a snapshot from the past and has no real bearing on the future.

But experience tells us that recessions tend to have general negative impacts on earnings, and the more leveraged sectors and industries geared towards growth will suffer more than more stable industries and sectors. This means heavier capitalized companies leveraged for expansion, such as resources, are more at risk than industries focused on necessities, such as utilities.

In terms of the COVID-19 troubles, lets turn to the Chinese economy and its primary stock index, the CSI 300 Index. This index tracks the 300 larger company stocks traded on the Shanghai or Shenzhen Stock Exchanges. The Chinese economy was slowing before the COVID-19 infections, and the impact of the virus only made things worse.

China is now post-peak in the COVID-19 outbreak and is rapidly returning to economic normalcy. But it’s still susceptible to drops in product demand from Europe, the US and beyond, and it’s also still impacted by volatilities in the US stock and bond markets.

China CSI 300 Index—Source: Bloomberg Finance L.P.

You can see that the index suffered its huge drop starting on Jan. 13 and bottomed out on Feb. 3. The recovery came as companies and the nation as a whole were getting back to work.

The index then hit a 12-month high on March 5. There has been volatility, including the dips largely following the nauseating drops in the US and European markets, but the index is still above its average for the trailing 12 months.

Similar recoveries have happened in the US markets as well, though for different reasons.

S&P 500 Index 1987-1989—Source: Bloomberg Finance L.P.

In October 1987, we saw the plunge that has only been rivaled in percentage terms this week. But as realities adjusted regarding the US economy and the underlying companies, investors returned to buying, with rising revenues and earnings sending the S&P 500 Index into growth gear again.

S&P 500 Index 1987-2000—Source: Bloomberg Finance L.P.

And that advancement largely continued to the peak on March 24, 2000. The resulting selloff from overleveraged dot-com companies would send the index down into 2002. But economic growth and investment would send it on a bull run into July 2007.

S&P 500 Index 2002-2007—Source: Bloomberg Finance L.P.

The underlying credit markets would begin to unravel that summer. And while financials were reflecting the changes in the economy and markets, the general stock market would wait until later in September 2008 for the bigger selloff.

S&P 500 Index 2007-2008—Source: Bloomberg Finance L.P.

And of course, the 2008 selloff was painful, but companies drew back investors eventually, resulting in one of the biggest and longest recoveries in US economic history.

S&P 500 Index 2009-2019—Source: Bloomberg Finance L.P.

This is not to say that the S&P 500 Index will just snap back in short order. I’m saying that as drops occur, so do recoveries.

Overnight and through this morning, I was monitoring developments from the Federal Reserve on the back of its liquidity actions yesterday.

And I was monitoring what was being worked out between the Administration and Treasury Secretary Steve Mnuchin and Congressional leaders. It’s a good start, and there will be more to come, especially in an election year.

Ahead of the open today, European and Asian futures are trading significantly higher. And in the US, S&P 500 Index futures were limit-up into the open.

There will be a lot to go through later today. And the moves by the Fed, the Administration and Congress have to be better.

I’m also poring over the model portfolios and the allocations. I’m considering raising the already large cash allocation for now. But more on that later, after this week is over.

All My Best,

Neil George
Editor, Income Investor’s Digest & Profitable Investing
Author, Income for Life