Stocks have dropped precipitously as investors anticipate recession and an accompanying credit crisis.

The S&P 500 traded down 7% within a few minutes of opening on Monday, a decline dramatic enough to trip a circuit breaker and force a 15-minute trading halt. Volatility is always uncomfortable but it is important, especially in times like these, to distinguish between market panic and a reasonable response to risk.
A rapid drop in global economic activity over the next three months or so is to be expected given the cost of the efforts to reduce the spread of the Covid-19 coronavirus. The dramatic drop in the price of oil today – down 25% in the wake of Saudi Arabia’s decision to flood the market with oil – also raises the risk of a credit crunch in the energy sector.
But U.S. consumers went into this crisis in a strong position, bolstered by a buoyant jobs market and a robust savings rate. We also know that the drop in mortgage rates – down to record lows – should support further strengthening in the housing market. At the same time, the plunge in the price for oil and other commodities will exert further downward pressure on inflation and free up discretionary consumer spending.
We’ve taken a fresh look at every stock that we own in our core U.S. equity portfolio, to evaluate the potential impact of recent developments to earnings. We believe that on average the earnings of these companies should be able to weather a short-term downturn. We have limited exposure to energy stocks or traditional commercial banks in this portfolio that would be hurt by very low interest rates.
More broadly, we believe that the economy as a whole is strong enough to withstand a short-term shock to the system. If it takes longer than three months to bring the virus under control, our views could change. But the progress in China, where the rate of new cases seems to be slowing significantly, suggests to us that our prospects of success are reasonable.
That’s the good news. More worrying over the long-term is the continuing – and now dramatic – reduction in interest rates across the maturity spectrum. Unless there is a quick snap back, it appears that the United States could be mired in the extremely low and possibly negative interest rate environment that has plagued Europe and Japan. This makes it difficult for banks to make money and for investors to earn a real return on capital without taking on significant risk.
Distortions in the bond markets already reflect this changing dynamic. Municipal bonds currently represent better value than Treasuries, upending their traditional relationship. But even at these low yields, bonds remain negatively correlated to stocks, providing valuable diversification as well as modest but more predictable income. Portfolio allocations to credit strategies and illiquid investment opportunities, two of our other asset classes, help generate further cash flow.
Rock-bottom interest rates also suggest that the market is pricing in another 50 to 75 basis point cut by the Fed on top of the 50-point cut made last week. That would bring us to within spitting distance of zero, leaving the Fed with little choice other than to revisit quantitative easing. We hope it doesn’t come to that and would prefer to see some fiscal stimulus to get the economy humming again; not an easy option in an election year but one that both parties might support in the current environment.
The S&P 500 ended March 9, 2020 down about 19% from its historic high, selling for about 17x trailing earnings, or roughly its average valuation over the past 30 years. We are more inclined to buy stocks then sell at this juncture, rebalancing portfolios to their equity allocations. However, the uncertain nature of this coronavirus and the potential for continued market panic give us pause. We will act on opportunities as we gain further confidence in the future earnings of individual companies.
We’ve endured market volatility before and, as we have in the past, we are advising clients to remain calm. If portfolio allocations are kept intact, investors should be able to recover from market drawdowns and stay on track to meet long-term goals.

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