May 7, 2020
As we’ve been speaking with clients over the last several weeks, certain questions seem to be repeated. So, in this update, I’d like to try to address some of them and provide some context to our thinking as we move through this era of economic disruption.
TO BE ABLE TO ASK A QUESTION CLEARLY IS TWO-THIRDS OF THE WAY TO GETTING IT ANSWERED. – John Ruskin
The most common inquiry we’re hearing is related to our view for a recovery, or the possibility of another market sell-off. I often tell people that if someone tells you they can consistently predict where the market is going in the next day, week, or month, then they’re probably not being truthful to you, themselves, or both. But, I do believe that looking further out on the horizon, say 18 months, does allow for much more clarity in terms of market direction. With that said, we think the economy and markets 18 months out will be in substantially better positions than they are now. I’ve used the analogy of hiking across a valley… we know that we’ll be able to get to the other side because we can see it, but what we don’t know is exactly what the terrain will be like between here and there. There might be streams to cross or rough patches to deal with along the trail. Nevertheless, we are very confident that we can reach the other side. In the current situation, we know that a vaccine is out there somewhere. It’s likely a year or more away, but it will be found. In the meantime, we may deal with more volatility as headlines about any number of things appear, but, we have the knowledge that we’ll return to a more normal environment in the future.
We believe that a return to the former level of economic activity, and associated corporate profitability, will take time. Certainly, we do not expect a run of 2% – 4% up days (as seen in late March and early April), that would bring us back to previous market levels. We’re watching market internals closely, and think they’ll continue to digest new financial data, and move forward in fits and starts. As for the possibility of another market sell-off, the probability of continued day-to-day volatility remains elevated. However, after the March shock, financial conditions are stabilizing, so we don’t predict another visit to the March 23 lows.
THE DESIRE FOR GOLD IS NOT FOR GOLD. IT IS FOR THE MEANS OF FREEDOM AND BENEFIT. –Ralph Waldo Emerson
Many Atlas clients have inquired about the use of gold as a position in their portfolio to hedge against economic uncertainty. I’ll tell you up-front that I have some very strong opinions about the use of gold, and more specifically about the misinformation that is used to market gold to investors. With that, I’ll point out that gold is a HIGHLY volatile commodity. The notion that it serves as a long-term “store of value” is misrepresented in my opinion. The case can be made that over hundreds of years, gold has performed well. My problem, with that line of thinking, is that none of us have hundreds of years to wait. In shorter periods, it does not exhibit anything close to consistent performance. In fact, if an investor bought gold at almost any time in the 1980-82 time frame, their real (inflation-adjusted) rate of return would likely be negative. We view gold as a tradable commodity, not an investment. There will absolutely be times when gold is an attractive speculative trade. But we’re investors, not speculators. As such, we don’t view gold as an appropriate investment for our strategy.
IF YOU OWE A BANK A HUNDRED POUNDS, YOU HAVE A PROBLEM. BUT IF YOU OWE A MILLION, IT HAS. – John Maynard Keynes
Another common concern to investors relates to the buildup of the U.S. debt, and what it may mean for our economy in the future. This is a topic that one could very easily spend weeks and hundreds of thousands of words describing. Given that I don’t have that capacity in this update, I’ll try to focus on the most important elements of the issue.
The current level of U.S. debt is approximately $24 trillion, which is more than the total output of the U.S. economy in a year. In 1988, it stood at about 50% of economic output. In the short run, growth in the federal deficit has provided for continued economic growth and the continuation of certain government spending programs such as social security, aid to certain industries and other countries to name a few. In the long run, it could come back to haunt us.
Think of it this way; many of us use credit to make purchases for items such as cars, homes, college educations, and other things that promote our lives, livelihoods, and overall prosperity. Most credit experts suggest keeping credit levels well below one’s total annual income. Further, if we can assume that our income will go up steadily, then taking on a certain level of credit debt for investment can make a lot of sense. For example, taking a mortgage at a young age that may consume 25% of a person’s starting annual income, but as they grow their income may only consume 15% ten years down the road.
But, what happens if that person runs up other credit debts by overspending on cars, entertainment, vacations, etc.? If their credit burden reaches a level that it cannot be paid off in a reasonable amount of time, they have a problem. They’ll either need to stop spending on non-essential items to pay down the debt, grow their income quickly, or default on their obligations. This is the dilemma for the U.S. Over the last several decades, the prevalent thinking has been that growth of the economy would offset the growth of the national debt. To some extent, that has been the case. However, looking forward, we are left with some new and difficult challenges. Without going into these too deeply, simply consider that the cost of Social Security is rising rapidly with the retirement of the Baby Boomer generation. Concurrently, with those workers retiring, growing the economy may become more difficult. The bottom line, in my view, is that we as a country will need to tighten the belt, spend less on certain government programs, seek ways to raise revenues, and reduce the total debt to a more manageable level in the coming years. Failure to do so will result in more negative economic consequences both here and abroad. I don’t assume to have the solution, but as investors, we would be wise to recognize this secular development and adjust our strategies accordingly for the future.
HOW MUCH WOULD YOU PAY TO AVOID A SECOND DEPRESSION? – Ben Bernanke
Related to this issue, some clients have asked about the possibility of another economic depression. First, I’d point out that if you were not already aware, we are currently in a very sharp recession. So naturally, people are concerned about the possibility of a capital D, Depression.
I recall in the late 1980s or early 90s, an economist published a book entitled (if I recall correctly) ‘The Great Depression of 1994.’ In it, he laid out his case for the coming cataclysm. Since then, we’ve been through the Asian Contagion of 1997, a war on terrorism, numerous natural disasters, and the Financial Crisis to name a few. Each time we see an increase in doom and gloom prognostications. Newsletter writers, bloggers, amateur economists, and so-called market experts pop up with predictions of disaster. Ignore them… PLEASE.
In the Great Depression, the Fed made, what is widely thought of now as severe monetary policy errors, and fiscal policy further obstructed recovery in the economy. The Fed was using contractionary policies in both the 1930-33 and 1937-38 periods, at both times essentially worsening those downturns. In addition, fiscal policies at the time put additional burdens on the economy. The message here is that while the possibility of an economic depression has not been extinguished, the tools and strategies in modern usage are far better and well-informed than those of the last depression. As mentioned above, we’re currently seeing a stabilizing of conditions, and while we don’t expect an immediate recovery to take place in the economy, the probability of falling into anything like what was seen in the 1930s seems very small.
Lastly, we’re frequently being asked: “what moves should be made to navigate portfolios through this period?”
While there are several things that have worked in previous event-driven selloffs and may work in this one as time goes on, our current observations are that for now, the leaders are still the leaders. What I mean by that… is that so far, sectors, styles, and strategies that were performing better on a relative basis early on seem to continue to be leading. Specifically, on the equity side domestic is out-performing international, growth still is outperforming value, and large-cap has maintained leadership over Small and Mid (SMID), despite a recent rally in SMID. On the fixed-income side it’s a little more mixed, but overall we are sticking with an overweight to intermediate duration Investment Grade (IG) bonds over high-yield or foreign. So, as was outlined in a previous edition of this update, we continue to think that patience is more important than force at this time.
That said, as we move through this situation, we are looking for the right opportunity to add leverage to a market recovery, or “add beta” as it is known. There are several ways to do this, through adding to certain cyclical sectors, smaller capitalized companies, or even through high-yield bonds. As an Atlas client, know that we have developed a four-phase plan based on research to adjust our strategies, are watching for market internals to begin to shift toward a sustainable recovery, and are ready to respond.
PATIENCE IS NOT THE ABILITY TO WAIT, BUT THE ABILITY TO KEEP A GOOD ATTITUDE WHILE WAITING. – Anonymous
As a final note, I cannot stress enough that patience and commitment to one’s long-term investment strategy are paramount considerations in times like these. Time after time in my career, I’ve seen investors make moves out of fear, a desire to time the market, or the mistaken belief that activity and action are the order of the day. In every instance of turmoil, markets have recovered and gone on to higher highs, recoveries began amid the worst headlines, and investors were late with their timing. Bold action in the midst of volatility sometimes works for speculators, but typically not for traditional investors. Be patient, focus on the 18-month horizon, and avoid making investment decisions out of fear or a desire to control the market. Please feel free to contact your Atlas Wealth Management Advisor if you have any questions about this or any other financial matter. As always, we are always available to serve you.
John C. Ogle