Many investors are focused on the extent to which the developing list of government interventions will offset the damage to the economy and business profits, and what they might mean for the timing of a recovery. While this is attention-grabbing stuff, and the fodder for discussions on the financial networks, it may not lead investors to the decisions that will benefit their portfolios through this market. Despite recent rallies in the major indices, we may be in for more rough sledding before a sustainable recovery truly gathers steam. It’s possible that we could see a period of up days based on good news around stimulus initiatives, and down days on virus news. That said, we are actively looking at the market’s internals to determine the most prudent ways to position portfolios to move through, and emerge from this in a positive position.
Regarding the economy we do think the second quarter of this year will show a somewhat disturbing contraction of the economy, both domestically and globally. However, in our opinion, a lot of that is currently priced into the markets. Using currently available data about the duration and opportunities to “flatten the curve” of viral infections, we are cautiously optimistic that by early summer the economy will begin to enter a recovery phase and think that the markets will begin recovering before the worst of the economic news has been released.
On a more practical level, we view the recent market activity as an “event driven” correction rather than either a “cyclical” or “structural” selloff. Given this, along with our preference for history rather than hysteria, we are working to cut through the current chatter and spend our time looking at what’s taken place in similar selloffs in the past, and use that information as something of a guide.
We know that over the last several decades, sudden event-driven selloffs have sometimes been followed by swift recoveries. This market, however, is challenged by the Coronavirus and widespread damage to the economy, so we wouldn’t predict an abrupt rebound. Nonetheless, other observations can help us to be properly positioned for the eventual recovery.
Often in similar events, the investment themes and strategies that worked well prior to the correction typically lag in the recovery. Over the last several years, we have seen the surge of passive/index investing, high asset class correlations and an environment where financial engineering rather than fundamentals led to returns. However, based on the current environment we think that market leadership in a recovery will be found in areas that investors may be avoiding or have been underweight to in the recent past, or simply investment styles that may have lagged in recent years. We believe we’re entering a market that will favor active management and stock picking, insightful sector allocation and tilts toward certain higher-beta areas. Accordingly, we are considering shifts to position portfolios properly for the future.
With recent market action showing some level of positive reaction to monetary and fiscal actions underway, I thought it would be a good time to help you to understand those programs and provide our perspective on what they may mean for the future of the economy and the markets.
MONETARY POLICY INITIATIVES
First, it is important to understand that the monetary policy steps taken by the Fed go well beyond simply lowering the Fed Funds rate to stimulate flows of money into the economy.
The following is a (very brief) outline several of the Fed’s alphabet soup of programs. This list is by no means a comprehensive account of the terms of these programs. In the interest of using real human language here, I won’t go into too much depth, but hopefully, this will provide you with some clarity on how the Fed is moving to support markets and the economy.
- Unlimited Treasury and Mortgage-Backed Securities Purchases- The name says it all…
- These purchases will be made to support smooth market functioning. This facility has already done much of what it was set up to do.
- Money Market Mutual Fund Liquidity Facility (MMLF)- This is aimed at maintaining liquidity and stability for holders of Money Market funds.
- This program is funded with $10 billion from the Treasury, opened on 3/20 and will close by 9/30. Funding will be provided by the Boston Fed to allow banks to purchase a variety of Money Market securities from eligible funds (prime, single state, or other tax-exempt money market funds).
- Commercial Paper Funding Facility (CPFF)- This vehicle supports the ability of companies to meet payroll and short-term inventory financing needs.
- This $10 billion Special Purpose Vehicle (SPV) will be available to purchase short-term commercial debt through the NY Fed’s primary dealers. This is a response to the issue of large amounts of commercial paper being sold as companies looked for short-term capital while Prime Money Market Funds were selling securities to meet redemptions, and sellers vastly outnumbered buyers in the market.
- Primary Dealer Credit Facility (PDCF)- This is a modification of the terms related to Federal lending to support the credit needs of households and businesses.
- By expanding the ability of certain qualified banks and other financial institutions to gain access to term funding, and extending loans for up to 90 days, the Fed is seeking to ease the flow of capital that supports parts of consumer and small business lending.
- Secondary Market Corporate Credit Facility (SMCCF)- SMCCF is set up to support the secondary market for corporate bonds by aiding liquidity.
- This program has $10 billion in funding from the Treasury that will be used to maintain liquidity in the corporate bond market. Bonds with a higher than BBB-/Baa3 rating, and less than five years to maturity will be eligible for purchase by qualified banks and financial institutions using the secured (recourse) funding facility.
- Term-Asset Backed Securities Loan Fund (TALF)- Another mechanism set up to help meet the credit needs of consumers and small businesses
- This facility applies to collateralized loans established after March 23, 2020 where the underlying collaterals are one of the following:
- Auto loans and leases
- Student loans
- Credit card receivables
- Equipment loans
- Floorplan (dealer inventory) loans
- Insurance premium finance loans
- Small business loans guaranteed by the Small Business Administration
Suffice to say that concerns of maintaining liquidity in bond markets, providing short-term capital to employers to meet payroll and inventory needs, and supporting access to capital for consumer needs is crucial right now.
FISCAL POLICY INITIATIVES
As of the time of this writing, the Senate has passed a $2 trillion package in a unanimous vote, sending it to the House for approval. That approval will hopefully occur on Friday, with the expectation of an almost immediate signing by the President. It is an 880-page bill, so many specific details are not widely known, but what is known is that the package offers specific relief to individuals, small businesses, the health care system and the corporate sectors. Some of the headline measures include:
- Direct payments to individuals – Up to $1,200 for individuals, $2,400 for couples with $500 added for every child based on 2018 or 2019 tax returns (according to those on file). There are income limits associated with these payments.
- Increases in unemployment insurance benefits – State unemployment benefits may be supplemented with up to $600 per week by the federal government, for up to four months. The bill also expands unemployment insurance eligibility to the self-employed and independent contractors.
- A tax credit for maintaining employees through the crisis – This is a 50% credit on wages paid during the Coronavirus crisis for certain businesses that have suspended operations or seen 50% declines in revenues,
- A pause on student loan payments due through 9/30/2020, with no accrual of interest,
- A delay on payroll taxes for businesses – Half of those payroll taxes can be delayed until the end of 2021 and the other half until the end of 2022,
- Health Care – $117 billion to support hospitals and veterans’ health care, and $16 billion for a national strategic reserve of medical supplies.
We would be happy to speak with you in more detail about our strategies. Please feel free to contact your Atlas Wealth Management Advisor to arrange a call.
John C. Ogle
Chief Investment Officer