We continue to live amid uncertainty driven by the global COVID-19 outbreak, and investors remain challenged as global financial markets attempt to price both the current and ultimate economic impact of its spread.
Not surprisingly, many of our clients – as well as their outside advisors – have many investment-related questions during this period, which we are answering across multiple formats. Each week we will feature answers to some of the top questions we receive, in an effort to provide a useful resource to navigate these turbulent times.
March 18, 2020
Investors started the week early, with the surprise announcements from the Federal Reserve on Sunday driving continued extreme volatility across global asset classes. Financial markets appeared unimpressed with the policy moves, with the S&P 500 falling more than 12% on Monday. A likely additional contributor to market anxiety was more significant social distancing measures being adopted and announced around the world, which heighten the risk of global recession.
Under the banner of “mood swings,” we experienced a bit of a reversal yesterday with global markets advancing as policy makers took aim at the crisis using fiscal weapons. For example, a proposed $1 trillion-plus stimulus package announced by U.S. Treasury Secretary Mnuchin buoyed risk appetite in the U.S., sending the S&P 500 up 6%. And today is another day.
Here are answers to some of the most common questions we are receiving:
We believe the Fed acted appropriately aggressive. While the market had already priced in the 100 basis point rate cut, some of the other measures announced were unexpected but necessary. One of the key issues in the global financial market right now is lack of liquidity. As companies draw down lines of credit, banks become more risk averse, investors de-risk their portfolios and the global flight-to-quality crescendos, liquidity has become scarce. The Fed needed to provide reassurance in terms of words and actions that it would provide liquidity. We expect the Fed to announce more policy tools over the coming days as it continues to focus on maintaining well-functioning money and credit markets.
For investors in risk assets, however, the Fed moves are considered necessary but inadequate, which partially explains the market reaction on Monday. The issues before us, in terms of the impact of COVID-19 on corporate earnings, are ones that lower interest rates/“cheaper money” cannot solve. As town, cities, states and now countries announce additional social distancing measures, many economists are forecasting recessions, which translates into a steep drop in corporate earnings. Currently, the important issue is how deep – and for how long – this will be? It is extremely difficult to forecast right now; however, we are beginning to see some fiscal policies aimed at offsetting the coming economic weakness. Further, we will soon have more data on the spread of the virus and any additional social distancing measures being implemented.
In certain industries, yes. Most notably, we are already seeing this take place in the energy sector, which is suffering from a decline in oil prices to 2003 levels. In fact, Occidental Petroleum is the first company to cut its dividend, lowering the payout 86%.
However, we do not expect to see a broad cut in dividends, as many companies have ample cash reserves and access to credit. Companies are extremely reluctant to cut dividends. That said, where we may see a broader impact is in share buybacks. Share buybacks have been a meaningful source of return for investors over the past several years, boosting earnings per share growth; however, the pace may slow in 2020 as many companies opt for a more conservative approach to deploying capital. Some banks, which have represented 16% of share buybacks, have already announced a stop to their share buyback programs.
That said, as we track buyback activity we observe that it is elevated, more so as equity prices have fallen meaningfully. Volumes are high, and technology and healthcare companies have been particularly active. We will continue to monitor this, although most companies will soon enter the quarterly earnings “blackout” period when buybacks are restricted.
This is first and foremost a global health issue, so any recovery would have to start there, quite literally. First, we will need to see a flattening of the infection curve, with lower growth rates of infection in the U.S. and Europe. Next, we need to see aggressive, targeted and effective support measures from fiscal and monetary authorities. We have seen dramatic action from the U.S. Federal Reserve and other global central banks aimed at stabilizing credit flow. And as we write, the White House and Congress are negotiating a stimulus package that looks meaningful, may buffer the direct hit to the U.S. economy, and could help both companies and individuals pay their bills during this difficult period. Further, with interest rates effectively at 0%, once the crisis period passes, we can expect recovery to ensue.
From a market standpoint, it will be a good sign when the market stops falling on bad news. Once we are able to look past the immediate period, which will doubtless be characterized by more bad news, and look toward recovery, the market may stabilize. We will also be looking closely for stabilizing/improving credit spreads – the difference in yield between Treasury bonds and those with credit risk, such as corporate bonds. Historically, credit spreads have been a fairly reliable early indicator of the future of stocks and the economy. These spreads have widened meaningfully as investors have shunned risk.
A core tenet of our investment philosophy is that Assets Serve a Purpose. In good times, and in challenging times, this holds true: What purpose do your assets need to serve? What goals do you need to fund, and when? These are always important questions, but they tend to come into stark relief during times of stress.
At Northern Trust, we aim to align your investment strategy with your lifetime of financial goals, with each goal assigned an asset allocation unique to the particular characteristic of that goal. During times of stress, we want to ensure that you can fund your most important goal, typically your lifestyle. We do that with a portfolio of Risk Control assets – cash and high quality fixed income. The size of that portfolio is entirely dependent on you: how much you spend and for how long you want to protect that spending. For investors with extra cash right now, there are lots of options using this framework. One option is to de-risk some of the goals you want to fund over time. For example, if you want to purchase a second home in five-to-six years, and the market downturn has lowered the probability of funding that goal, you can consider adding cash to that portfolio.
Another option is to identify an additional goal: Perhaps you want to take advantage of some of the planning opportunities associated with the low rate/high volatility environment by funding a GRAT or extending an inter-family loan. With every decision, the starting point is the same: What are your goals, and what is the best way to fund them?
Periods of market stress always create pockets of opportunity, and it’s important to recognize that Northern Trust and other professional money managers will continue to use their expertise and analysis to identify those opportunities and take advantage of them in client portfolios. That said, we do not think now is the time to make significant asset allocation adjustments or attempt to time the market. Recent action in the market reflects the danger in making dramatic changes to portfolios, as investors have routinely been whipsawed over the past two weeks.
But there are many wealth planning and tax strategies that can actually make more sense in market downturns, which we suggest exploring with your advisors. Examples include Grantor Retained Annuity Trusts, traditional-to-Roth IRA conversions and substituting assets in trusts. For a longer list of ideas read "Six Wealth Planning Strategies for Stressed Markets," and follow-up with one of our advisors.