When a pivotal economic event takes place like we are experiencing with the coronavirus pandemic there are certain trends that begin to either arise or quickly accelerate. We think the latter is currently happening with Ecommerce. It is no secret that for many years online shopping has been taking market share from brick and mortar retail. But never before have we seen a scenario where many brick and mortar retails were forced to close shop and deemed “non-essential”, while the large online market places became the essential way for consumers to get the goods they needed. Some could argue that Amazon & Walmart, the two largest Ecommerce retailers, became a staple of national security for their distribution capabilities as citizens are quarantined in their homes.

Much of this gained business is due to many small retailers simply being forced to close for several months, but we think that Ecommerce retailers will keep a good portion of the gained customers even after government shutdowns are lifted. In late April during Microsoft’s Q3 earnings call, CEO Satya Nadella remarked that “We have seen two years’ worth of digital transformation in two months” as Microsoft provides part of the digital infrastructure that Ecommerce retailers use. The graphics below show the dramatic penetration that online sales have reached along with the industry distribution due to this new world of the government forcing citizens to stay in their homes...

_{Federal Reserve Action and Market Volatility} 

In late March the Federal Reserve established the SMCCF (Secondary Market Corporate Credit Facility) to support credit to employers and provide liquidity for financial markets.

These new credit facilities gave the Federal Reserve the ability to purchase a larger array of financial products than traditional quantitative easing techniques previously allowed. This included the ability to purchase large amounts of investment grade corporate bonds through SPVs (Special Purpose Vehicles).

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One central part of our investment philosophy that we constantly preach is owning companies that have strong balance sheets. What this means is that they have limited liabilities including debt on their balance sheets as well as low working capital requirements. We also look for those companies that have large amounts of cash on their balance sheets. When these strong balance sheets are paired with good capital allocating management teams future returns tend to be strong in both up and down markets. Goldman Sachs recently created “strong balance sheet” and “week balance sheet” baskets of stocks with the former outperforming the latter.

Strong Balance Sheets Outperform Weak Balance Sheets

Source: Goldman Sachs..

What’s Driving Equity Markets

Fiscal response has been impressive and is a primary reason why markets have seen such a sharp rebound from their mid-March lows. In a note that came out last Sunday Goldman Sachs’ economic team wrote that “disposable personal income is likely to register slightly positive growth for the year” attributed to the stimulus payment program rolled out by the government has been so robust. This prediction is predicated on the passage of ‘Phase 4’ of the government's response so not a done deal yet. We think this forecast for disposable income to actually grow in 2020 is on the optimistic side but the fact that the government has seemingly been able to buoy consumer spending is one of the reasons for the sharp bounce back in markets in the last month...

2020 Earnings Update 

Strict government-imposed restrictions including shelter-at-home policies did not come into place until mid-March across most of the country. This means that the impact to corporate earnings will not be reflected fully in first quarter numbers but more completely in second and third quarter results.

First quarter earnings have so far been fairly solid with most companies reporting results in line with initial expectations. As expected, most companies have been cautious with giving too much insight into what upcoming quarters numbers will look like. Roughly half of S&P 500 companies provided 2020 EPS guidance through the end of February. If early reporters are any indication than many of these companies will continue to not give 2020 guidance or withdraw previous projections. ..

Reopening of the Economy 

The next step as we move through this virus pandemic is the reopening of the economy and a return to normalcy. Although the “reopening” of the economy is talked about as a singular moment where economic activity is resumed, we see it as more of a process that will take place over the next 2-3 quarters. The economy being “open” is one thing, but the return to normalcy is the more difficult time window to predict. It may take years for several aspects of the economy to return to pre-virus conditions. Financial markets, particularly the fixed income market, have likely been changed for a significant period of time on behalf of the unprecedented central bank stimulus taking place across the globe.

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Where We Are in The Life Cycle of COVID-19

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Case Growth

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Volatility in Oil Markets 

One pocket of the capital markets that has seen elevated levels of volatility is the commodities sector, particularly crude oil products. On the supply side, recent negotiation fallouts have led to a price war being waged between Saudi Arabia and Russia. At a time where output cuts were trying to be reached by OPEC+, two of the largest oil producers on the planet have maxed out their production capacity flooding the market.

The demand side of the shock comes from the halt in economic activity brought on by the virus outbreak and government shutdown. Without people flying, driving, or transporting goods, demand for crude oil and refined products have dropped off the map. ..

I have attached our most recent update to the Coronavirus response and economic outlook. Find the update here>>04082020-Q2-2020-COVID-19-Impact-Update.pdf

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I thought you might find this update helpful to understand the government’s actions to stabilize the economy. Lawmakers finally came together on a bipartisan stimulus package that was signed into law on Friday, March 27^th. The $2 trillion dollar stimulus package known as the CARES Act will act as a lifeline for businesses and employees while the government shutdown persists. The graphic below breaks down the different buckets of the package and how funds are being distributed. 

On top of support for large and small businesses, the bill also provides support for hospitals and drug makers that are working to fight and contain the virus. Details are still being provided on the logistics and timing of payments and programs, but officials have been adamant about rolling these out as soon as possible...

Now is the time to look forward and stick to a plan of action. Virus pandemics have a lifecycle that they go through and just like every life cycle they are not exact but can be useful as a timing tool. This framework is important for us as we navigate this volatility and make tactical investment decisions. Our timing will never be exact but what is important is that we are not basing our investment decisions on panic rather than sticking to realities and our core investment philosophy.

The current coronavirus cycle is broken down into 5 stages. Right now, we are crossing over from stage 2 to 3. After the initial spotty cases across the country now we are seeing person to person transmission and the number of total cases to expand dramatically. Our transmission rates have been on par with other countries, but our mortality rate is significantly lower, and we think that will continue to be the case on account of our more robust health care system and better hygiene standards...

Peak in Global Infection Rate

Worldwide infection numbers continue to grow as most of the world remains in shutdown.  The service sector has been especially badly affected, with consumer facing industries bearing the brunt of the social distancing measurements. Although domestic health centers are strained, they have not been overrun such as those in Italy or Wuhan, China...

Day to day the media is reminding you to wash your hands and avoid large crowds as new coronavirus cases pop up across the world. What they should also be discussing is what else you should be concerned about; your cybersecurity.  Global disasters such as the coronavirus creates a golden opportunity for fraudsters because the whole world is informed and constantly trying to learn more about said disaster. This causes a greater potential for impulse clicking on suspicious emails or attachments. The fraudsters know this.  Starting in February 2020, a new coronavirus phishing scam has popped up in the United States. So, not only do you have to worry about the coronavirus outbreak hitting your area but now you must be on the lookout for the latest e-mail scam! These scam artists are trying to prey on the fear of the outbreak, hoping that you’ll impulse click on their seemingly legitimate e-mail and it’s working.  

So how are these cybercriminals getting you to click on their e-mails and links? Scammers are sending e-mails pretending to be from the Centers for Disease Control and Prevention (CDC) or the World Health Organization (WHO) offering to provide an update on confirmed coronavirus cases in your area or luring you in with a link to see “safety measures” to combat the spread of the virus. Why do consumers believe these e-mails are real? One reason may be that the sender’s e-mail address at first glance could look very legitimate. The scammers create addresses that look very similar to the real organizations, making it very hard to catch. Another possible reason is that they also will copy and paste the organization’s logo in the e-mail to create a sense of legitimacy. Let’s look at a few examples of fake e-mails below.  ..

Life Cycle of a Virus Pandemic

Now is the time to look forward and stick to a plan of action. Virus pandemics have a life cycle that they go through and just like every life cycle they are not exact but can be useful as a timing tool. This framework is important for us as we navigate this volatility and make tactical investment decisions. Our timing will never be exact but what is important is that we are not basing our investment decisions on panic rather than sticking to realities and our core investment philosophy.

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How do we navigate this unprecedented market environment? While the circumstances of the Coronavirus/Oil War are extraordinary we are in the midst of a major crisis. Simply put, in a crisis there are certain actions we must adhere to as long-term investors until this crisis passes. We use historical precedents as a guideline, but every crisis is different. What isn’t different is how we approach them.  This is not a time to be frequently trading long term positions locking in losses under irrational circumstances. Once the virus hysteria passes, events and gatherings return to normal, and fiscal stimulus is launched by the government the market will stabilize. The stock market rewards investors who are long term oriented. While others are selling their shares out of panic, it creates an opportunity for those who want to buy a stake in those companies with the mindset of a long-term part-owner. Stocks of great companies are selling off because the market is predicting that their earnings will be punished at least for this year, but their long-term business prospects remain the same. This is where mispricing occurs in the market. We do not know if this virus outbreak will worsen or accelerate before it subsides, but we do know it will subside.

It’s easy to be a long-term investor when the market is ratcheting higher with very little volatility which has been the case over the last few years (excluding December 2018). The difficult part comes when the markets begin to sell off for a public panic such as a virus outbreak. We are investors, not traders. We buy stakes in good companies, pay a reasonable price for our stake in said companies, and then let those businesses operate and compound our capital over time. This might seem simple but it’s important to understand what drives returns and why this is the most effective strategy for long term investors.

Equities are one of the best long-term investment vehicles, because they are the only asset class that continuously re-invests a portion of your capital. When you buy real estate or commodities such as gold and silver your capital is not automatically reinvested (assuming its value appreciates, or you earn rent, royalties, etc.). But rather a new opportunity must manually be found. Historically, this can be difficult over long periods of time as the competition of capitalism works its magic. When you own a high-quality company, this capital is typically being reinvested by experienced management teams who have expertise in their field with a history of operating businesses at the highest level.  This capital reinvestment creates a ‘compounding’ effect over time which is the way that wealth is created...

I’d like to share with you yesterday’s insights from Schwab Chief Investment Strategist Liz Ann Sonders in response to the economic implications of the COVID-19 and the recent crash in oil prices.

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The current scene of volatility in the markets is one that we do not take lightly or underestimate the degree to which financial markets can work themselves into a panic. We understand that the current selloff this past week is difficult to endure. Based on our financial planning and investment management approach our client portfolios have been designed for every possible environment, good or bad. Fortunately, our portfolios are designed to prepare for such circumstances as we are currently experiencing. You have a financial plan that has incorporated an emergency fund of cash representing 6-12 months of cash needs so that you would not be forced to sell assets at the wrong time. Our yield bias of dividend paying stocks provides ongoing cash flow support and our focus on large capitalized proven enterprises has proved to be protective in these environments as well. Our total avoidance of international and emerging market funds has also served to protect our client’s assets.

Under these circumstances, it is important to keep things in perspective. An over accommodating Federal Reserve has given us 10 years of rising markets without much volatility. The market typically falls by 5% or more three times a year. It falls 10% or more about once a year. And it falls 20% or more about once every seven years. We are just not used to this volatility. This increased risk and uncertainty, however, is why the equity market over long periods of time return almost double that of the bond market which has much more predictability. This market selloff has been abrupt which raises concern and makes it psychologically more damaging but still the worst thing you can do in the middle of a selloff like this is to panic and let your emotions dictate investment strategy.

When you look over long periods of time like in the chart below you clearly see we have these 10% corrections at some regular intervals. What is important to notice is that they happen fast, and they are followed by longer bull markets. Looking at the chart, the worst thing to do is sell when we are in these red bear markets...

The recent outbreak of the Wuhan Coronavirus is a topic that is at the forefront of all investors’ minds, particularly since information out of China is spotty and the numbers that are supplied by the Chinese government need to be met with high scrutiny. Many would wonder how the world’s second largest economy seemingly grinding to a halt would not cause a market sell off. The market reaction thus far has been relatively muted for several reasons:

The first reason is the derivative effects of the virus that the market is currently pricing in. The market is confident that China will be able to relatively contain the virus before it becomes a full-on Global Pandemic. From what we know now, the mortality rate from Coronavirus is relatively low. Figure 1, located below, plots the Coronavirus mortality statistics against similar outbreaks. As this is being written, only two deaths have been confirmed due to the virus outside of China. In the last few days several Chinese factories have announced that they are resuming operation and workers are returning to facilities. A minor detail that may soften the impact to U.S. companies’ inventories is that the virus outbreak has taken place over the Chinese New Year which is a period where factory output is predicted to be depressed. What the market is then pricing in is that once economic production resumes, economies will undergo a sharp increase in activity to make up for lost production due to the virus. Think of this as a “V-Shape” bounce on a graph.

Another derivative effect that the market is looking forward at is Central Bank stimulus. Just in the last few days the Peoples Bank of China injected 900 billion yuan (about 129 billion U.S. dollars) into the Chinese financial system. U.S. investors are predicting that the impact from the virus, and subsequent impact to GDP, will cause the Federal Reserve to continue to be accommodative via their own repurchase operations and possibly another rate cut. Many companies that have reported numbers in the last month have also given wide forward-guidance due to uncertainty from their supply chain status. This should dampen the shock that investors will get if subsequent numbers are materially impacted from their production or inventory drawdown...