April 3, 2020
After reaching all-time highs in mid-February, global equity markets exhibited sharp declines as the scope of the coronavirus pandemic became evident. The declines also extended to most fixed income markets as investors rushed to sell assets to raise cash. During the last two weeks of March, credit markets stabilized due to massive intervention by the Federal Reserve and other monetary authorities. Equities also regained a portion of their declines as unprecedented fiscal measures reinforced monetary actions. The following performance summary shows continued relative outperformance of U.S. equities. Returns over almost all periods are below long-term historical averages:
Over the next few months, economic activity will be dominated by efforts to slow the spread of the coronavirus or at least “flatten the curve” by restricting important sectors of the global economy through sheltering-in-place policies. These efforts will result in a significant contraction in economic activity, and headline numbers will be startling, including jobless claims & non-farm payrolls, manufacturing activity, GDP, and corporate earnings. However, the response on the monetary and fiscal fronts, particularly in the U.S., should at least mitigate the impact and improve prospects for an eventual economic rebound. The Federal Reserve is providing unlimited liquidity to financial markets, supporting fixed income markets through the purchase of a wide range of securities. These efforts arguably prevented the health crisis from morphing into a financial crisis and resulted in the stock market transitioning from a falling to a bottoming process.
On the fiscal front, the U.S. government has enacted three programs with a total value of well over $2 trillion. These programs are designed to assist individuals and corporations, both small and large, in offsetting at least a portion of the economic contraction’s impact. A “Phase 4” program is likely to follow, which might focus on assisting states and local authorities in dealing with the effects of the coronavirus. An infrastructure program might also be included, which would consist of the healthcare sector as well as traditional targets such as roads and bridges.
The timing of an economic recovery is highly uncertain since it will depend on the course of the virus. At some point, economies will reopen. The timing will reflect evidence that the lifting of restrictions on economic activity can take place without reaggravating the spread of the virus. The impact of the extreme monetary and fiscal measures being taken will improve the chances of a strong rebound in economic activity. Empirically, event-driven recessions are shorter in duration (less than ten months) and have quicker faster recovery times. At this point, our best estimate is the first quarter of 2021 looks like the most likely time for a significant recovery to become evident. However, global stock markets are a leading indicator and will anticipate the recovery before it is visible in economic data.
Unprecedented: Historically, it takes global stocks an average of eight months to enter a bear market. This time it took less than one month – the fastest ever:
15%+ quarterly drops for the S&P 500 are uncommon, only nine since World War 2. The good news, the S&P over the next year was higher 7 of 8 times for an average gain of 16.6%:
Our priority over the past year has been to purchase quality long-term growth companies while reducing our exposure to economically sensitive holdings. We have continued these efforts over the past several weeks, and we have sold several lower conviction holdings. Our goal is to replace these holdings with great companies that are unusually depressed and will re-emerge from a position of strength. Recent new additions have focused on the Healthcare and Information Technology sectors. Despite an uncertain near-term earnings outlook, we have maintained our Financials positions, where select companies have structurally improved their business models and balance sheets since the prior recessions.
To prepare for a volatile few months, we have compiled an investment list of stock ideas to be ready to respond to and take advantage of declines. Our criteria focus on long-term growth, high profitability, low debt, and reasonable free cash flow valuations. Further, we have split the list into “Now” and “Later” investments. “Now” are stocks we are comfortable owning through the volatility and include several Tech, Health Care, and Defensive companies. “Later” are stocks we believe will rebound more sharply after the bottoming process ends and include more consumer, small business, and industrial activity exposed companies. We think there will be several sustainable changes to consumer and corporate behavior following the coronavirus recession. However, we are not chasing the stocks that are up the most as a result of the outbreak.
In our Dividend Growth Strategy, we believe a depressed global interest rate environment should increase the attractiveness of companies paying healthy dividends. We continue to emphasize resilient free cash flow and dividend safety for our holdings, and our largest sector overweights are Technology and Health Care vs. comparable strategies. We are avoiding high dividend-yielding companies with high payout ratios, as we expect many companies to cut or eliminate dividends over the next few quarters.
In our managed Exchange Traded Fund portfolios, our diversified equity exposure remains tilted towards Value, Quality, and Mid-Cap fund styles. We maintain healthy exposure to Emerging Markets, which we favor over International developed markets, and we prefer Equity Income funds for value exposure. Within fixed income, we favor quality Preferred Stock funds for higher-yielding exposure to complement our short-duration investment-grade holdings. Tracking error, liquidity, and low expense ratios remain key considerations in fund selection.
Fixed Income Strategy
The spread of the coronavirus was reflected in a massive decline in U.S. Treasury interest rates during the first quarter. Between December 31, 2019, and March 31, 2020, yields on the two-year Treasury declined from 1.57% to 0.25%. The five-year Treasury yield fell from 1.69% to 0.38%, while the ten-year Treasury yield declined from 1.92% to 0.67%. At the same time, the yield differential (or spread) between Treasuries and all other categories of taxable and tax-exempt securities widened substantially.
With current yields in the taxable market at such a low level, staying with a shorter than average duration seems a prudent strategy. The massive monetary and fiscal stimulus runs the risk of causing an acceleration of inflation once the economy recovers, and yields on longer-term obligations would then become more attractive. In contrast, the sharp rise in tax-exempt yields is creating attractive opportunities in individual securities, albeit on a highly selective basis.
The percentage yield of 5-year AAA municipal bonds vs. the 5-year U.S. Treasury bond is at historically high levels. We believe this presents opportunities in select issuers:
During these unsettled times, communication is of paramount importance. In addition to our investment updates, please call, email, or videoconference our team. We will always be available. Our top priority is to ensure you have comfortable exposure to stocks, bonds, and cash to withstand these volatile periods. In closing, we wanted to revisit one of our favorite charts as a reminder to “focus on time in the market – not trying to time the market.” Many of the market’s best days occurred not far from the market’s worst days.
Princeton Global Asset Management, LLC
Important Disclosures: This report is for informational purposes only and contains data based on information Princeton Global Asset Management (PGAM) believed to be accurate. However, PGAM cannot assure the accuracy of the data. Past performance is not a guarantee of future results. Portfolio holdings and characteristics are subject to change. The information in this report should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of these securities transactions or holdings that may be cited were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of securities cited.