The Road to Recovery
Dear Clients and Friends,
As we celebrate Independence Day, we are reminded of the many freedoms that have been restricted since the onset of the Covid-19 pandemic. Celebrations of life, graduations, weddings, retirements, and funerals have been postponed indefinitely. We have even had to restrict those more routine liberties that many of us took for granted such as going to a ball game, eating at a favorite restaurant, or hopping on a plane for a family getaway.
Speaking of travel, many of us are choosing to hit the road this summer instead of flying, and in many ways, we see consumer choices as driving the road to recovery for jobs, the overall economy, and markets.
The road to recovery has already taken many twists and turns. Since the beginning of the year, broad markets declined 34% from the peak before recovering more than 20% in the second quarter of 2020—the fastest bull market in history. Meanwhile, oil prices and short-term Treasury rates journeyed into negative territory (one of many “firsts” this year), and job losses continue to compound resulting in the highest unemployment rate since the great depression. We continue to expect the unexpected as the pandemic unfolds, but we have rising confidence that markets and the economy will gradually improve.
Markets Follow the Fed
With Jay Powell behind the wheel, the U.S. Federal Reserve has played a major role in helping the economy and markets find their way. After reducing the Fed Funds rate to nearly zero in March, the Fed said it would provide financing including loans of up to $2.3 trillion to consumers, employers, financial firms, and local governments in a series of efforts to blunt the pandemic’s economic impact.
Don’t fight the Fed, a well-known investor mantra, seems alive and well at this point in time. The current bull market began on March 23 when the Fed announced these stimulus programs. During the second quarter, the Fed executed several creative and much-anticipated stimulus packages that included buying corporate bonds and junk bond ETFs (exchange traded funds) in an effort to support credit markets and investor sentiment.
We expect the Fed to keep interest rates low for one to two years, but we think sustained rates below zero are unlikely as the idea of ultra-low rates has proven disappointing. European markets have experimented with negative interest rates for years, but the region’s growth remains sluggish.
Portfolio Management in the Time of COVID
The Bear Scenario: As events unfolded in the second quarter, we saw a slew of contradictory signposts that suggested the possibility of a slow and difficult recovery. Amid the dissonance, we asked ourselves tough questions about another potential leg down for the economy and markets. Would a second COVID wave lead to additional quarantines and reduced economic activity? Would the first wave of lockdowns and job losses lead to a slippery slope as people and companies fall into bankruptcy?
The Bull Scenario: On the other hand, the skies could open and the road to recovery could become much more manageable if we see additional federal stimulus and if COVID testing, treatments, and hospital protocols boost consumer confidence. Ultimately, the bull market scenario will rely upon the successful discovery and administration of an effective vaccine. At the moment, we believe that this more favorable scenario may start to play out in 2021.
As we wrestled with these scenarios during a hectic second quarter, our primary goal was protecting client investments from additional losses. We executed on this strategy by maintaining cash levels, reducing equity positions in companies tied to the economic cycle such as banks and industrials, and adding to defensive holdings in healthcare and consumer sectors. We also added to technology companies that are demonstrating growth even during the pandemic. In addition, we continued to selectively purchase fixed income where we continue to favor short term Treasury bills and corporates.
We are rolling our defensive posture into the third quarter as we anticipate a handful of milestones that could create some turbulence on the road to recovery. In mid-July, banks will likely report potential credit losses that may disappoint investors. Then in late July, fiscal stimulus checks may run out if the government fails to enact additional legislation supporting unemployed people or offering back to work bonuses. By the end of the third quarter, we anticipate rising credit concerns as distressed consumers hit deadlines to pay back loans.
While things may get bumpy in the near term, we do expect the economy to recover in time. When a vaccine seems more imminent and we can see a path towards its ultimate execution, consumers and businesses will feel more confident, which should translate into greater hiring. Eventually, more jobs should generate more cash available to recycle back into the economy, which should eventually alleviate credit concerns.
Looking ahead, we plan to gradually transition our defensive posture toward re-deployment of capital into new investments that we feel will have more upside ahead. We look forward to entering the second half of the year as the economy and markets recover, committed to our core investment principles and ever mindful of your goals and objectives.
Wishing you a Happy Fourth of July and a safe summer,
Michael Bailey, CFA
Director of Research
Michael Mussio, CFA
Note: The CARES Act previously enabled taxpayers to waive Required Minimum Distributions (RMDs) in 2020, while also allowing those affected by COVID to return RMDs already taken by extending the “60-day Rollover” deadline. Last month, the IRS expanded this relief by extending the deadline to return all un-wanted distributions to August 31. Please call your Portfolio Manager at FBB Capital Partners to discuss whether this new provision is relevant to your individual needs and objectives.