Pandemic, Black Swan Event, and Your Portfolio
We now know that the U.S. Government knew in late January that the Covid-19 virus was a game-changer and would have a dramatic impact on our population, economy, and social interactions. One month later, the stock market hit a peak on February 19th. From there, we saw the quickest bear market in history develop, and the dreaded “Black Swan” event was upon us. The stock market declined by over 34% in short order and investor panic was palpable.
It seems like yesterday, yet the last eight months have been a minor miracle. Let’s recap for some perspective. In March, Compass Rose moved to 100% cash in client discretionary accounts for the first time ever. We were concerned that government leaders, corporate executives, and public health officials did not have a sufficient grasp on what to do in response to the virus threat. In hindsight, with America losing 220,000 lives as of today, our skepticism seemed to be well placed.
However, in some important respects, we were wrong. In fact, government leaders did some incredible work. The Federal Reserve came to the rescue of the credit and stock markets, Congress along with the White House provided immediate financial relief, and state Governors took on the battle to stem the spread of the virus and shore up health care facilities and workers. Corporations geared up to provide protective equipment, medical devices, possible vaccines, and therapeutic drugs. It was not perfect, far from it. But here we are eight months later and we are in better shape, economically and financially.
Back in late March, Compass Rose began to put money back to work in investments that we thought would do well in the pandemic economy. Despite the fact that the economy was in recession, there were opportunities to invest in companies that would grow their sales and earnings like never before. By early April, we were virtually back to our normal investment percentages. The market surged for two months, paused, and then resumed the upward climb. By August, the market hit all-time highs before taking a well needed rest in September.
You may ask, “why would the market be so strong when the economy was so weak”? The answer is that market always looks out six to nine months in deciding what stock prices should be today. And, the market saw a recovery for many segments of the economy and reversion to profit growth in 2021. While we have many parts of the economy still disabled, even those sectors are anticipated to recover over the next two years.
For your portfolios, the steady and powerful recovery from the March lows was spectacular. All discretionary portfolios have outperformed the market since April though today. For the largest portfolios, they are all positive for the year. This amazing turnaround is due to a very large extent to active portfolio management. Stock picking has been absolutely key.
Our outlook is for the near term is cautious. There are three reasons for our concern, and we will turn our attention to each below.
For voters, there are clear differences between the platforms of our two major parties. So, next month, America will decide on future direction, and it remains to be seen whether a decisive decision is made to change direction or whether to stay the current course. We are not concerned about the outcome of the election in terms of investments. We can deal with either outcome.
What can adversely affect us is an election where the winner is not known for an extended period of time. Markets dislike uncertainty and not knowing the winner for a month, two months, or longer will surely hamper the markets. However, let’s be clear. If the winners are not known for a week or two, that is not a big deal. We have lived through that before with Gore versus Bush, and we still prospered.
The real threat is that democratic institutions and norms could come under attack. If there are widespread domestic protests and perhaps violence because of the perceived election result, that will be negative. If there is no clear winner and the Electoral College cannot declare a winner, that will also be a negative. If there is a change of leadership, and there is no commitment to a peaceful transfer of power, that will be negative, since a Constitutional crisis would ensue.
So, our hope is that the election has a clear winner within three weeks, that there is no serious social unrest, and the normal swearing in of the President occurs on January 20th. The markets will like that scenario.
Please know that we are not taking a political stand here one way or the other. That job is up to the American people. Our job is to protect your investments as best we can.
The Stimulus Bill
In the Spring, Congress and the White House came through with flying colors to provide a safety net to the economy and millions of citizens that were adversely affected by the closing of major parts of economic life. The legislation passed then has provided a financial bridge that was essential. Today, there is an additional need for another stimulus bill that will get us from now to a possible health care solution to the virus by the Spring/Summer. The stimulus bill is caught in a political morass, with both sides not wanting the other side to get a win before the election. So, perhaps in a month, we can achieve agreement on the next financial bridge. It is not optional. Without a decent stimulus package, there will be human and economic damage done, some of which we will not recover from. So, stay tuned and hope that wiser heads prevail.
There have been 141 possible vaccines and therapeutics in the research stage. Some have already been discarded due to ineffectiveness. A few therapeutics have had impressive results and may significantly lower the mortality rate of the virus. There are a few possible vaccines that are entering the final research stage and many scientists believe it is possible to have one or more vaccines in the next few months. Regardless of the timetable for a vaccine(s), it should be known that the schedule for the manufacturing and distribution of the vaccine is unclear. In the U.S., manufacturing agreements are in place, giving us some measure of optimism. It is possible that the distribution plan in the U.S. will be fairly straightforward. We have been dispensing inoculations every year for as long as we can recall.
It is not clear if manufacturing and distribution is assured for the rest of the world. The process is expensive and as of this date, there is no global plan to finance and carry out vaccine dissemination. If other parts of the world lag in dissemination of the vaccine, global economic growth will be negatively impacted, ultimately limiting domestic growth and earnings.
Finally, apparently, there are some individuals who oppose vaccines completely. It is not clear how many fall into this category, but if it is a substantial number, the U.S. will not achieve the public health scenario where full restoration of the economy is possible.
So, stay tuned to the Election, the Stimulus Bill, and the Vaccine dynamics and be aware of the impact on your investments. We will, as always, monitor these key events and adjust our approach to investment management accordingly. Our advice … hang in there and vote!
- Please be advised that everyone with earned income is entitled to make IRA (Traditional and Roth) contributions for 2020. The maximum amount for those under age 50 is $6,000. For those fifty and over, the catch-up provision permits a max of $7,000 for the year.
- The Cares Act, passed this year, includes a provision that Required Minimum Distributions for IRAs and other retirement plans are not mandatory this year. However, if you need the funds, you can still take the RMD. Please contact us if you fall into this category.
- Reminder: there is still time to make charitable contributions and capture a potential tax benefit for 2020. Please call us if you would like to review your individual situation.
- Every year, we provide an early warning on realized capital gains in taxable accounts so that clients can prepare for the April tax deadline. We will personally call each client in early December to provide specifics on the realized gain in each account.