Special Edition: Covid-19, the Markets and Early Hopeful Signs

On a special edition of Stock Talk, CIO Chris Perras provides an update on the market, COVID-19, what we see happening “behind the scenes,” and what that may mean for the markets going forward.

Chris Perras: Hey, my name is Chris Perras. I’m Chief Investment Officer at Oak Harvest Financial Group in Houston, Texas, and welcome to a special midweek podcast of our weekly Stock Talk Podcast: Keeping You Connected to Your Money. First off, there is no denying that headlines, fear, and rhetoric surrounding the coronavirus has become the primary driver of investment performance over the past five weeks.

While the duration and volume of COVID 19 virus-related news is yet to be determined. We continue to counsel our clients and prospects to control what they can control. Investors should be mindful that perspective matters. In investing, time horizon always matters. The longer the holding period, the lower in assets volatility and the higher one’s expected returns. This is relevant to all asset classes including bonds and stocks.

At all times we advise clients to try to remain calm and rational in their decisions. However, particularly in times of high volatility like we’ve seen the past five weeks, we advise investors to remain poised and patient in their decision-making and to trust the investment process and financial plan. I know it’s hard to do but the time to make asset allocation changes is during times of calm in the markets when emotions are running low.

As of this recording, we were sitting near 2,425 on the S&P 500 and that’s up almost 9% on the day. From the February 19th high of around 3,385 on the S&P 500, we have fallen almost 28% from our all-time highs in only five weeks as volatility has spiked historically fast and the markets have fallen at a speed last seen in October of 1987. I do remind listeners that the rapid October 1987 sell-off was the low for the next 10 years of a 20-year secular bull market.

Historically, bear markets and higher rates of decline can and do happen during ongoing secular bull markets. This rapid decline comes on the back of dramatic selling increased volatility, in not only equity markets, but perhaps more importantly also in commodity, currency, and bond markets including the safest US Treasury bonds. Please go back and listen to our podcast about two weeks ago titled Collateral Damage.

The selling has been indiscriminate, case in point, the supposed low volatility ETF the SPLV, as in, Victor we’ve referenced in the past podcasts dropped two times as fast as its sister, the high volatility ETF the SPHB as in boy. This is exactly opposite of what investors in the markets think is supposed to happen in these ETFs. The supposedly boring and stable utility sector, XLU ETF, dropped over 35% in March. To put that in perspective, the tech-heavy QQQ ETF dropped only 22% during that same period.

On this podcast, I want to list a few of the early positive signs we started seeing late last week and earlier this week that give us some hope that while markets should remain volatile for a few more months, the peak and market volatility might be behind us. With that in mind, I titled this podcast; Early Healing Signs. First, the spread of the virus through China, which was its origin, and Korea has peaked. They’re slowly starting to return to work in those countries per Starbucks Coffee in China and the semiconductor orders out of Korea. Those are both positives.

It looks like the measures to slow the virus down they started taking in Italy are showing through this past weekend with a slowing in new cases and deaths in that country for the first time in three weeks. After China, Italy had been the worst country for the outbreak. The United States is finally ramping testing for the virus and we’re increasing social distancing both which proved in China and Korea to mute the virus about two to three weeks later.

On the technology and medical front, the entire scientific world is now solely focused on finding a drug or drug combination to combat existing virus cases and also to develop a vaccine for future use. The World Health Organization has launched accelerated trials for four of the most promising virus treatments. The studies will include thousands of patients across dozens of countries. In the attempt to flatten the curve, as everyone calls it, governments and public health agencies are looking at using current compounds and looking to repurpose existing drugs that have already performed well in two previous deadly Coronavirus outbreaks, SARS and MERS.

Late last week, a virtually unknown market-maker called the Ronin affirmed that traffic in some of those absurdly constructed volatility ETF products was shut down and their portfolio was sold and distressed. The last time an event like this happened was in February of 2018, factoring that Volmageddon time period that we spoke about in the past, which was near the short-term trading bottom of the S&P 500 for the first quarter of 2018.

Other news that’s positive on the volatility front. One can look forward to the options markets in the second half of 2020 and see that those markets are starting to price in a sustained decline in volatility starting on around after July 4th. This is a positive sign for the stock market rebounding and sustaining that rebounding sooner than most investors think. It looks like longer-term professional investors, ones whose careers are based on pricing investment risk and volatility, are beginning to either see an upturn in the economy in the second half of this year or a solution to the virus or hopefully both.

From a monetary standpoint, the Federal Reserve has pledged an unlimited supply of liquidity to many credit markets, including treasuries, mortgages, and some other corporate debt. They should help stabilize some of the credit and collateral markets, which is not only a good thing for fixed income markets but it also bleeds into equities and help stocks as well.

Remember back to our podcast on collateral damage two weeks ago, we discussed the unprecedent rise in treasury bond volatility. Recall US Treasury bonds are assed to be the safest and least volatile collateral in the world. They are perceived to be “riskless” as they were backed by the full faith and credit of the US government. The volatility in treasuries rose from its normal three to four volatility level to over 16 mid-last week. As of this morning, while the measure is still very high, it is back below 10. The collateral markets are trying to thaw and a thawing of those markets would produce higher confidence and higher asset prices across the board including both bonds and stocks. This is another positive sign.

In currencies, the safer currency markets that attract capital during times of stress. Think of money flowing into the ultra-safe and boring Japanese yen and out of the dollar, or think of it flowing into the dollar from emerging market currencies like Korea, those safer currency trades began reversing late last week. Late last week, the dollar began strengthening against the yen, that’s positive, and the Euro/Yen currency cross began rallying. That too is positive.

Another positive sentiment indicator showed up yesterday in that several prominent investors who were early to voice their concerns over the economic impact of the virus have said they started buying into the markets again. The most notable of these investors was Bill Ackman of Pershing Square with his recent statement that he was using that two and a half-billion dollars in equities and his purchases included Starbucks and hotel stocks. David Tepper of hedge fund fame also said he was beginning to find opportunities in both bonds and stocks.

Another semi-obscure stat starting to turn positive late last week was within the hedge fund world. The leverage statistics at hedge funds and risk parody funds that we’ve talked about in the past have dropped considerably over the last two weeks. This means they have already sold meaningful amounts of stocks. This means the amount of loans these firms use to buy stocks have been fleshed out and we shouldn’t see as much selling from these group all at once. These loans have been called and their underlying positions have been liquidated.

Another point, valuations. Valuations have dropped significantly the last six weeks. The S&P 500 had been trading at almost 20 times trailing earnings in mid-February because the economy was accelerating and interest rates were low. While forward earnings guidance is currently impossible to predict, the market has quickly adjusted its valuation down to about 14 times trailing earnings, which has historically been a very good entry point for investors The last 30 years.

The markets have already priced a recession into the markets. Long-term investors know that the dollars they invest during recessions while uncomfortable have been the highest compounding return assets over the subsequent 2, 5, and 10 years. Buying assets when others are forced to sell or you’re just emotionally panicked has been the best way to compound your returns at higher rates over time, Buying strong balance sheet, high-quality, dividend-paying, and dividend growing stocks and reinvesting those dividends over time into more shares of those companies has been a proven long-term strategy for building wealth in stock markets. I know that six weeks ago sounds like years to most of us in our lives right now. The virus and our economic response have caused a historic slowdown in the global economy. However, I remind listeners how strong things were in the US economy and how much of our economy and the markets can recover quickly on the other side. New home orders for January and February pre-virus were up over 20% per the homebuilder Leonora.

Leonora is one of the nation’s largest first-time homebuilders. Millennials were just starting their early household formation buying patterns. That will only accelerate on the other side of this virus and become a secular trend that lasts 10 to 15 years as they grow older, their families form, and they purchase, just as the baby boom did, in their 30s through 50s. Besides homes, they are going to be buying stocks for their eventual retirement.

Trying to predict the final timing events like the virus, what has transpired in the last five weeks is impossible. The markets in the economy are being hit with a historic event. However, our Federal Reserve, through its monetary policy, elected officials through unprecedented fiscal action, the scientific community through global coordination, and our shared public sacrifice to social distancing are also historic firsts, and taken together, they’re being used to combat this virus.

Have the last five weeks been fun? Certainly not. These are the events that bring increased anxiety to savers, investors, and communities in general. Listeners, please remember, your highest compounding returns come from buying equities during economic downturns, regardless of their cause. One of the worst things you can do is to sell your positions and go to cash during times like this. History has proven over and over again, that long-term investors with patience and the ability to tune out the noise make the most money and have the greatest security down the road.

On this podcast, we’ve tried to highlight a few of the behind-the-scenes optimistic tilting things we started seeing lately last week and early this week. At Oak Harvest, we pride ourselves on being comprehensive long-term financial planners. What this means is that as our client, you and your financial advisor should have a financial plan that is independent of the volatility of stock markets.

For now, investors should maintain a balanced approach to asset allocation given the uncertain nature of the outbreak. Anxiety and risk aversion is likely to continue into the second quarter ahead as our country implements measures to fight the spread of the virus here in the States, which undoubtedly will cause short-term negative growth. We will emerge from this on the other side, stronger and growing.

If you are retired or in the process of retiring, please give us a call at 281-822-1350. We are here to help you plan your financial future and help smooth the financial path you have into it and through your retirement years with a customized retirement planning. Many blessings, this is Chris Perras with Oak Harvest Financial Group.

Speaker 2: The proceeding content expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, statistics, and sources are not guaranteed. Content ideas and strategies discussed may not be right for your personal situation and should not be considered as personalized investment, tax, or legal advice, or an offer or solicitation to buy or sell securities. Investing involves the risk of loss and past performance does not guarantee future results.