Since my last email, events have evolved further concerning the Coronavirus (COVID-19) and the markets. Additionally, we have seen another (unrelated) event drive equity prices down further. In this update, I’d like to apprise you of the new developments and the steps we’re taking in response.
It is evident, the momentum of the Coronavirus is building here in the U.S. and is having significant impacts on the culture and economy. College classes are being cancelled, the NBA has suspended its season, a block has been placed on foreign travelers from Europe to the U.S. and more workers are being encouraged to work from home. While its impact on economic growth will not be fully understood for some time, I am convinced that if this trajectory maintains… it will be more harmful than any of us estimated just days ago.
Last weekend, talks between OPEC and Russia about curtailing oil production to support prices broke down. The response from Saudi Arabia was to begin dumping crude oil into the market which almost immediately drove crude prices from the upper $40’s to the low $30’s… this spells trouble for the U.S. oil industry. As the growth of U.S. oil production has provided a boost to jobs growth in the U.S., we may begin to see a reversal of the employment trend of the last couple years. Other effects could involve banks and junk bond investors that have made loans to smaller operators in that area. For some companies that have not managed their debt prudently, this increases risks in the near term.
Accordingly, we are elevating our probability estimate of a recession in the next 12 months above 50%.
The markets have continued to react with volatility. The S&P 500 index has been up and down, and as of the time of this writing stands at a level that erases all of the performance of 2019. Credit spreads (as described in my last email) have widened to the point that indicates concern is spreading. Treasury rates have plummeted, and as recently as Monday the 9th, a 10-year U.S. Treasury note was yielding just over 0.50%… that is a historic low.
What may provide some solace in this is the fact that the changes we made to our portfolios late last year have helped this situation. We improved the overall quality of our fixed-income holdings, moving away from credit in favor of interest rate exposure. With rates falling recently, this strategy has worked quite well. In addition, the reductions to equity exposures that we implemented in December and January have mitigated the downside as compared with our previous strategy. Further, we’re heartened that our active allocations are showing their value as compared with the various indices and peer groups that they operate in. Without getting into the exact numbers for each, it is clear that our active managers are mitigating the damage being done as compared with a fully indexed/passive strategy. Finally, our tilts toward Growth (as opposed to Value style), and the defensive positions we hold in the Health Care sector and Communication Services have served to cushion the equity market decline.
This week we made shifts where possible to protect the gains we’ve realized in the bond strategy, and will hold proceeds in an investment-grade, short-term bond fund. This is aimed at protecting some of those profits against the possibility of a back-up in interest rates. We would expect to see a rebound in rates in the coming months, and will await that before making further adjustments, possibly re-establishing positions in the intermediate part of the yield curve.
The situation in the markets right now is fluid, and we are remaining watchful. As Warren Buffet has been credited with saying, “Be fearful when others are greedy, and greedy when others are fearful.” With the market developments this week, we believe that we are approaching the time to be greedy.
We think that in the next two to three months, concerns about the Coronavirus will begin to wane, and with the investment community then looking toward a recovery in business conditions later in 2020 into 2021, the markets will tend to rebound fairly quickly. While we’re not looking to make significant changes or turn aggressive on equities, we are considering prudent steps to position for a market recovery.
We continue to note that maintaining a well-diversified portfolio is key to coming through these times well. We encourage our valued clients to remain composed, as we at Atlas remain watchful for opportunities to enhance our portfolios for your long-term wealth accumulation.
As always, if you have questions about this, or any other financial matter, please feel free to contact your Atlas Wealth Management Advisor.
John C. Ogle
Chief Investment Officer