Client Letter

March 20, 2020

Dear Clients;
 
            Thank you so much for your serenity during this time of uncertainty.  Your patience and confidence is greatly appreciated.
 
As we continue to endure the uncertainty and market volatility associated with the coronavirus, we thought it would be helpful to point out some of the factors working in favor of not only the economy but also the markets.  The uncertainly is likely to recede only when the rate of infection comes close to a peak.  However, there are some considerations that should put a floor under the economy as well as financial asset prices.  First start with a few qualitative factors that are important to remember.

• Just about everyone in the medical community believes that the impact of the outbreak will be transitory with a limited duration.  In other words, whether it takes six weeks or six months, there is already light at the end of the tunnel.  We know this because life in China is beginning to resume as usual now that the crisis has become manageable both inside and outside of Hubei province. It is true that in order to beat this disease the Chinese government had to implement some pretty draconian measures.  But if that's what it takes, that's what we must do. 
• Second, we need to remember that this year is an election year.   Everyone knows that the best way to gain power is through strong leadership and successful management of this crisis.  Everyone knows the stakes; failure is not an option.
• And finally, we must keep in mind that unlike the Global Financial Crisis, nobody is at fault for our current predicament.  This is a very important consideration because there will be no concerns about bailouts and other support for those deemed to be responsible for the crisis. 
  • Our leadership, to include the presidential administration, Congress, and the Fed, is unlikely to face much backlash for implementing draconian and very costly measures to successfully defeat the virus. 
  • The public will be much more amenable to sacrifice in response to an uncontrollable force rather than an identifiable villain. 
  • A virus cannot be vilified or punished by the press or at the ballot box.
  •  The American people have shown repeatedly throughout history that they have the grit and determination necessary to prevail.

 
The following are more tangible reasons that the economy, after suffering an almost certain recession, should be relatively resilient and quicker to bounce back.  These factors include the following:

• Notwithstanding our continuing concerns about economic inequality, the consumer's financial health is relatively strong.  The consumer Debt Service Ratio, which measures how much of the consumer's disposable income goes to household debt service payments, is at multi-decade lows.  In addition, savings rates are currently quite high, which means the average consumer has some rainy-day money.
• The consumer is receiving an effective tax cut in the form of mortgage refinancing and very low gas prices. 
• Business investment remains quite depressed.  While relatively low business investment has been a perennial drag on GDP in recent years, that is actually a good thing as it relates to the depth of any downturn. 
• Residential investment's share of GDP also remains below long-term averages.
• The trade skirmishes with China, Europe, Canada and Mexico have held back exports as a share of GDP compared to the levels we expect once trade agreements are firmly in place.
• Business inventories are currently fairly low, which limits the impact of possible inventory draw downs as a response to the crisis.  However, there is good reason to believe companies will actually be building inventories, in many cases, as supply chains are affected by the virus.
• In the near term, the economy will be supported by consumer spending on goods and services (think health care) to protect against the virus or its worst effects.
• Perhaps most obvious, the government is going to go much further into deficits as a result of tax rebates and spending related to the coronavirus.  Though the magnitude is not yet known with certainly, we may be looking at annualized deficits of between $2 and $3 trillion in the initial stages of the response.  A deficit of $2.5 trillion would equate to about 11%-12% of GDP, an amount that would make Keynes blush.  However, these deficits will be required to support the economy in order to prevent a rapid increase in unemployment.  The current super-low level of interest rates should allow the federal government to fund these deficits at a very low cost.  There will be ramifications later for running up this debt, but now is not the time to worry about that. 

There will come a point when investors accept the risk of owning stocks rather than buying bonds that will result in an almost certain loss of purchasing power (because bond yields are below the current rate of inflation).  The current estimate for S&P 500 earnings next year (2021) is still about $190, which puts the current price-to-earnings multiple at just 12.6x. .  If we apply a rather aggressive 30% cut to those estimates, which will clearly be revised down in the coming weeks, the multiple goes to 18x. And importantly, under invested young people are finally getting an opportunity to start saving at lower valuations, which, over time, will result in higher returns.  Investing at lower valuations lowers the cost of saving for retirement, which is one of the consumer's largest expenses - just one more hopeful sign.
 
Hang in there, keep your wits about you, and stay well!   We will get through this together. Please let us know if there is anything we can do for you in these challenging times. 
 
Your friend and financial planner,
Brien