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Early Spring 2020

It is only seven days since we last wrote to you concerning the coronavirus health crisis and the market response to the unfolding pandemic.  Today, we want to bring you up to date on what has happened in the last week.  If you need a refresher on where we were one week ago, please read our email message from March 13th.

Here is the latest on the virus, the health care system, the impact on the economy, and how we have managed your portfolios in response to a rapidly changing world.

  • One week ago, we were cautiously optimistic that the U.S. Health Care System could make progress to catch up to the virus challenge.
  • Events over the past week have dampened that optimism as we have learned that testing kits are in short supply, protective equipment for doctors and nurses is sparse, ventilators exist in inadequate numbers, hospital beds are in short supply, and we may soon face inadequate facilities to meet the health care demand.
  • Our Federal government has been slow to respond to the above issues and has decided not to use emergency powers to meet shortages and build temporary hospital facilities. The military and national guard units are not mobilized to construct temporary facilities to augment the ICUs that exist.
  • In the past few days, the number of new virus cases is beginning to grow at an exponential rate. The number of fatalities is starting to follow the same trajectory.
  • The hope that we could have a miracle vaccine and other measures that might ease the crisis is just that… a hope. The scientists continue to tell us that significant advancements are off in the future. At best, we might have enough luck to find existing drugs that can be redeployed to lessen the virus impact.  But a vaccine is well off in the future.
  • Our efforts to implement social distancing and sheltering in place ramped up this week, but there are expert voices suggesting that the effort is tardy and not fully rolled out across the country. The critical decisions on these measures have been left to the States and localities, resulting in uneven guidance to the public.
  • Last Monday, Saudi Arabia and Russia launched an oil price war for supremacy in the oil markets. Without getting into the specifics of why this is occurring, the critical point is that the vast majority oil and gas production in the United States became unprofitable overnight. This will mean that companies will shutter production where they can and operate unprofitably for the short term. There will be economic hardship as markets shrink, layoffs occur, and bankruptcies will commence.
  • Further economic damage has begun to happen as workers have been laid off in retail and entertainment and as small businesses shutter their establishments. Unemployment numbers will rise to levels unheard of only three weeks ago.
  • Government programs are being enacted to mitigate the economic damage. However, we fear that the government’s ability to act swiftly will be challenged. If those programs do not reach families and small businesses immediately, then the economic impact will spiral as people cannot pay rent, mortgages, & bills and as they struggle to put food on the table.
  • There are now major industries that are at a standstill. Hotels, restaurants, cruise lines, airlines, car manufacturers, casinos, and even churches are closed. Government assistance for several of these industries is being considered, but no substantive legislation has passed yet.
  • The Stock Market is functioning well (liquidity is fine). However, the bond market and fixed income markets are showing signs of a liquidity crisis. This means that normal trading is now impaired, and the Federal Reserve has had to step in to provide emergency liquidity. The Federal Reserve has even had to shore up liquidity in the money market system.
  • In response to these events, the stock market has sold off, reaching negative 30% year to date. Unlike other times, the bond market does not offer a safe haven. There have been significant losses in virtually all fixed income investments.  In the last week, even U. S. Treasuries, have suffered losses.
  • The Black Swan event that is the coronavirus is touching our lives, changing individual behavior and eroding our national economic strength. Sobering thoughts, but you need to know where we are in this national crisis.

Compass Rose’s response:

  • In mid-January, we began to take profits in positions that were clearly over-valued, locking in some of the gains from last year.
  • In February, we identified the riskier stocks in all portfolios and began systematic trimming of those positions. By early March, we were out of the riskier positions completely.
  • Those steps left us with only high-quality stocks, ones that are financially strong, and usually more stable in price.
  • At the same time, we trimmed higher risk, fixed income positions, opting for what are usually stable bond positions and solid income producing instruments.
  • As the Black Swan event unfolded, it became clear that panic in the markets resulted in investors selling both lower quality and higher quality positions. They just wanted to dump positions and get to cash.
  • The wholesale dumping of all investment classes in the markets prompted us to go to over 50% cash on Monday in the portfolios to protect assets. However, we wanted to maintain small positions in a few great companies, should there be a rebound from over-sold conditions.
  • By Wednesday it became clear that the markets were engaging in full blown panic selling, where everything was being sold at any outrageous price.
  • On Thursday, our goal was to get to at least 85% cash, with only two small equity positions and a few short positions. We worked tirelessly with Schwab to get the best prices possible, and those efforts were successful. In the mutual fund (smaller value) accounts, we went to cash except for one short position.

The bottom line is that we are on the sidelines now, awaiting new developments and signs that we may return to normal times in the coming months.

Given our cash position, we will do well if the market further declines (because the cash position will not lose value). However, we will give up any potential gains on up days in the markets.

Our strong conviction is that there is likely to be more down days than up days as the health care crisis gets increasingly serious, the economy suffers and, in the first week of April, corporate earnings are reported for the first quarter.  We expect corporate earnings to fall off the cliff since March is going to show a steep decline.  And, we expect forward guidance from the corporations to be dismal, if they give guidance at all.

We invite your feedback on a rapidly developing health and market crisis.  We pledge to continue to closely monitor every development, adjust our outlook, and make further investment decisions that may improve your portfolios.  But rest assured, we are in a very conservative mode and it will take real improvement on all fronts to get us to actively invest significant sums in the near term.  Eventually, the market will let us know when to get back in, and then we will act.  In the meantime, we are hunkered down trying to preserve every dollar that we can.  We hope you value these efforts.

Please follow the precautions advocated by our health care professionals.  Take care of yourselves and reduce exposure to others as much as possible. And, please take care of each other. Rest assured, we will eventually beat this challenge to our country. We will get through this and then rebuild our economy and health care institutions better than ever.  We all need to be Patriots now and all pull in a constructive direction.  We will triumph!

All the best!

Dr. Jim, Karen, Jim S and Roxanne