INVESTMENT QUARTERLY

THOUGHTS FROM A REMOTE COVID-19 BUNKER

Sitting in my bunker to comply with the social distancing of Coronavirus or COVID-19 has brought back some personal family remembrances. I never knew my maternal grandfather as he passed in 1918 from the Spanish Flu. Until recent news reports I had no idea this earlier pandemic caused over 50 million deaths world-wide and 675,000 in the United States. All I knew was that my grandfather had died from the flu and my grandmother came down with it as she tried unsuccessfully to nurse him to health. Fortunately, my grandmother survived and lived until her late 80’s. This second-hand remembrance of events from 101 years ago has given me an understanding of the impact this virus can have on families for years. My plea to all of you is to take this situation seriously. Please follow medical and government directives designed to curtail the spread of the virus. We wish you good health.

We have closed our office until further notice, but we continue to work remotely from home. We will provide the same responsive service that you, our clients’, have come to expect. It is amazing how much you can do with Facetime and Zoom. We hope you will call on us if we can do anything to help you through this crisis.

Before getting into our usual economic discussion, it might be helpful to discuss some important changes that can impact your financial situation. In a recent quarterly we discussed one change the SECURE ACT brought to IRAs. In addition to shortening the years a beneficiary IRA could run to 10 years, the act delayed the age at which one has to start required minimum distributions (RMDs) from 70½ to 72 years old starting in 2020. The CARES ACT grants a waiver to all IRA or 401k owners who skip their required minimum distribution in 2020. It even allows those who have already taken a distribution in 2020 to put it back in the IRA as long as it is redeposited within 60 days. All funds redeposited in this manner are not subject to income tax in 2020. If you do not need your annual distribution for your annual living expenses, you might want to consider this benefit.

We hope all of you have established estate plans to provide for yourselves and your families. It is probably a good time to review these to make sure you are utilizing them to the fullest extent. You should review your Health Care Proxy and Durable Power of Attorney to be sure that they still reflect your wishes. These two items are primarily for your benefit but can also help avoid family disputes if you are incapacitated. If you have a trust or trusts, you should be sure that there are not any changes you should make as your family has aged. If you have trusts you also want to be sure that your assets are properly registered so that they end up where you want them without having to go through probate. And, if assets are not properly registered you could end up with unbalanced estate values and lose the federal or state estate tax exemptions that your plans were originally designed to capture. If you haven’t put plans in place, there is no time like the present to create them for you as well as for your children over eighteen. It looks like COVID-19 will be with us for a while so hopefully you have some time to get this done, but starting early is the best approach.

The economic problems caused by COVID-19 are likely to be significant and long lasting. It is likely that there will be significant changes in personal and corporate behavior as a result. It is also likely that the world will fall into a recession in 2020. What are the chances of a depression with potential 20 percent unemployment, and how do you tell the difference between the two? Someone once said, “If you lose your job it’s a recession, but if I lose mine it’s a depression.” A recession is defined as two back-to-back quarters with negative Gross Domestic Product. A depression is a longer lasting and deeper recessionary period. The world-wide economic impact of this pandemic is so severe that any recovery will likely take longer than normal. The speed of the latest market decline set a record as the shortest time for the market to decline over 30%. This gives credence to the Wall Street adage “The stock market goes up on an escalator and down on an elevator.” The Dow Jones Industrial Average dropped 38% from its February highs only to quickly rebound by 26% after the Treasury and Fed announced their programs to flood the market with liquidity. Volatility is the order of the day.

The strength and speed of the rebound has caused some analysts to project a swift economic and Coronavirus recovery leading to a strong equity market. A recent chart comparison of today’s decline and recovery with a chart during the Great Depression shows a similar early pattern. In the depression period the initial market recovery was really a bear market rally following which the market declined over 80% and the economy required years to recover. Only time will tell which of these scenarios will prevail.

If we look at the economic damage already caused by the COVID-19 it is severe. While the Atlanta and New York Fed GDP formulas project first quarter GDP of between 1.5 to 1.7 percent, the Blue-Chip Consensus forecasts a negative 2%. For the second quarter an early forecast by Goldman Sachs projects a horrendous decline of 34 percent. If the Blue-Chip and Goldman forecasts are true, we will be in a recession with two negative quarterly GDP results. We need to see first quarter results, paying close attention to corporate guidance on revenue, to get a good idea of where the economy is likely to go. With streets empty, people aren’t buying so sales will continue to be weak. First quarter results will not reflect a full quarter of declining sales so second quarter results could be worse. People’s consumption behavior changed in the Great Depression so it will be interesting to see what develops from the current environment. The consumer is 69% of our economy historically and 84% of the period since 2014 so consumer spending will determine how rapidly the economy recovers. Balance sheets will be more important than income statements now.

Companies can never cut expenses fast enough to keep ahead of falling sales so there will be a huge negative impact on earnings and cash flow. Lower earnings and cash flow could lead to dividend cuts if companies don’t earn their dividend, or need the cash to make interest payments on outstanding debt. Focusing on high stock dividend yields could be treacherous without an understanding of the effect of falling revenue on earnings. Even if the economy is slow to recover though, current and future stimulation programs could provide enough liquidity to move the market to short term highs if there is any good news on the rate of infections, discovery of a treatment or the development of a vaccine. It is a dangerous time if the market does one thing while the economy does another. Right now, with all the economic uncertainty, chasing yields is like trying to catch a falling knife.



For the quarter the Dow Jones Industrial Average returned a disturbing -20.0%, the Russell 3000 Index a negative 18.4% and the S&P 500 a modestly better, but still disappointing, -17.2 percent. The Bloomberg 1-5 year Corporate/Government bond index returned a positive 2.1% as the Fed’s move to a near zero rate posture provided one of the few bright lights for the quarter. The unexpected landing of the COVID-19 Black Swan caught the market by surprise and took no prisoners. Early forecasts for the second quarter may not give the equity market much support either.

Robert B. Needham, CFA