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BFG MARKET UPDATE FOR MAY 11, 2020

May 13, 2020
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COVID-19 has continued to affect the markets with increased volatility. Although some of the uncertainty has decreased over the past 7 weeks, there are still a lot of questions of uncertainty including when and how fast the economy will recover, and will there be another surge of the virus in the months ahead? 

Government Response

The government has responded to the shutdown of the economy with both fiscal (government spending) and monetary (actions by the Federal Reserve) policy. Several bills have been passed resulting in $3 trillion to help combat the cost of COVID-19 as well as to help generate economic recovery. These various bills have been created to help individuals (stimulus payments), small businesses (Paycheck Protection Program), airlines, and local governments. There are also several other bills currently being proposed to help assist the restarting of the economy. 

The Federal Reserve’s actions have been just as significant, if not more important, as the actions of Congress. They dropped interest rates to near-zero, to provide less expensive access to capital for individuals and businesses. The Fed also added liquidity into the banking system to help pump more money into the economy, and in addition they purchased some bonds (including mortgage-backed securities) to help drive down long-term interest rates. One of the most significant actions that the Federal Reserve took was announcing that they would be a buyer of high yield corporate bonds and municipals bonds. These securities markets had very few buyers, and prices were being driven even lower. Upon the Fed’s announcement regarding their intent to invest in these securities, the markets leveled off and surged forward (even though they had not purchased a bond yet at that time). This single action helped calm all of the investment markets as there were many concerns regarding the potential for corporate and municipal bankruptcies. Having the Federal Reserve as the lender of last resort increased the confidence of what were at that time many skeptical buyers.

 Equity

The US equity markets bottomed out, with the S&P 500 closing down 33.9% from its previous high on February 19, 2020. Although the drop in the stock market was very fast, the market has begun to rebound very quickly as well. As of March 11, 2020, the S&P 500 had gained 31.0% from the March 23rd low point. As of this writing, the S&P 500 is still down 13.5% from its February 19th value. (One note on required return of recovery:  The market was down 33.9% from the high, which means the market needs to return 51.3% from its previous March 23rd low in order to reach the previous high point again.)

US large-cap equities are rebounding faster than small-cap or international equities. In a bear market, small company stocks usually fall further than larger company stocks. The Russell 2000 (an index for small-cap stocks) was down 43.7% at its lowest point and was down 22.9% as of the close of business on March 6, 2020. International stocks have similarly not rebounded as quickly to this point.

 Bonds

Interest rates decreased as we went into the COVID-19 crisis, which generally has a positive impact on bond prices.  This was the case with US Treasuries, but was not necessarily the case with other types of bonds. With increased corporate risks, credit quality was affected with many corporate bonds, which these bond prices down. The lack of spending over the last seven weeks has decreased sales tax revenue, which in turn has put great financial pressure on state and municipal bonds. This type of economic conundrum initially sent municipal bond prices falling rapidly until the Federal Reserve came to the rescue of this market as a buyer, which in this case added some necessary stability. Therefore, a diversified bond portfolio did not rise by as much as the equity dropped based on all these factors. Similar to the stock markets, the bond markets have stabilized somewhat, but they currently are still very volatile.

 Real Estate

We hold minimal real estate in our investment portfolios, but it is still an asset class that needs to be addressed. Real estate has been negatively impacted by the recent turn of events, and there is still a lot of uncertainty in real estate markets. It is unknown how small businesses will return as the economy ramps back up, and many of these businesses pay rent. With rent payments uncertain, and at best delayed, there are very few buyers in this space to drive down prices as well as a lack of consistent rent revenue to drive down earnings.

 Key Takeaways

The markets have started to recover based on more recent optimism, although there is still a lot of uncertainty.  As market expectations for the reopening of the economy change (either positive or negative), we expect a continuation of volatility, and perhaps even an increase in volatility. If there are delays in the reopening plan and/or a resurgence of the virus, then we could see the stock market react negatively once again. If we see the plan continue to go well, and particularly if we see evidence of positive results concerning treatment and/or vaccine development trials, then we can expect the markets to continue to recover quickly.

 Our strategy continues to be buy-and-hold for the long-term. Our strategies of taking less risk on shorter-term funds have continued to work, and longer-term funds are recovering even quicker than expected thus far. As always, please feel free to reach out any time to any of our advisors if you have any general or specific questions regarding our market expectations, or our investment strategy.