Taking a SWOT at Q1

Posted In: COVID-19 Market Update

The first quarter of 2020 was certainly a challenge for the stock market and our “proud to own” picks. The economic fallout from COVID-19 had a far greater impact than any of us could have ever imagined, and it appears that the fallout might last for quite some time.

  • The S&P 500 dropped 646 points or -20.3%
  • The Dow declined by 6,620 points or -23.3%
  • The Nasdaq fell 1,272 points or -14.4%

International stocks didn’t fare any better, as the EAFE international index lost  -24.5%. Worse yet, small company stocks were hit the hardest, plummeting -31.2%.

 

In reviewing the first quarter, as well as looking ahead, it is often helpful to focus on the Strengths, Weaknesses, Opportunities, and Threats that exist.

 

STRENGTHS

Governments and Central Banks around the world have been throwing all their power and might toward combatting the economic consequences of COVID-19. The U.S. Federal Reserve (the Fed), the European Central Bank (ECB), and the Bank of England (BOE) all have instituted massive support to provide liquidity and stability to the markets.

 

In the United States, the Fed cut key interest rates twice in March, lowering interest rates down between 0% and 0.25%. Additionally, the Fed announced a $700 billion quantitative easing program, with purchases of $500 billion in Treasuries and $200 billion in mortgage-backed securities. These actions helped to provide much needed liquidity, so businesses could continue borrowing during this time of great need.

 

Other countries also followed suit with rate cuts and quantitative easing. The combined action of the Fed, as well as other global central banks, helped to stabilize Treasury bond yields. Treasury yields had been rising when the stock market was falling, which is abnormal. When stocks and bonds fall at the same time, it is an indication that investors are liquidating all assets and going to cash.

 

After the global central banks took action, the 10-year Treasury stabilized at 0.75% and the 30-year Treasury at 1.28%. This stabilization fueled a rally in dividend stocks, which has been a strong positive in all of this.

 

Lastly, the governments around the world have also rolled out massive stimulus/relief packages to provide stop-gap measures for the economies of the world. Here in the U.S., Congress passed the sweeping $2 trillion CARES Act designed to provide relief for individuals and businesses most impacted by the virus.

 

WEAKNESSES

As the COVID-19 pandemic spread globally, country-wide lockdowns, stay-at-home orders and self-quarantine efforts became commonplace. These measures have closed schools, businesses, and canceled conferences, entertainment and sporting events.

 

Because global supply chains were disrupted, millions stopped working, making a worldwide recession inevitable. This pushed the stock market into a bear market. Markets hate uncertainty, and these shutdowns have made it difficult for companies to accurately gage the full economic impact that COVID-19 is having on their businesses. First-quarter GDP in the U.S. is now expected to contract 5% or more with unemployment expected to rise to 8% or more.

 

OPPORTUNITIES

China has been able to get back to work with factories reopening and the upcoming end to lockdown in Wuhan on April 8. That was the epicenter of the coronavirus outbreak, but new coronavirus cases have been zero for five consecutive days. China appears to be trending in the right direction.

 

Optimists believe auto plants, stores, and restaurants could reopen in the U.S. in late April or early May, as quarantine restrictions could be lifted in the upcoming weeks. As temperatures rise across the U.S., new COVID-19 cases should decline (even if only for the summer months), and business should get back to normal.  As soon as the stay-at-home orders are lifted, we are expecting the U.S. economy to resurge.  The resurgence will be buoyed by any advances on the medical front during these summer months.

 

The markets are in the process of bottoming.  We have witnessed a large wave of capitulation selling on high volumes (moving to cash), as many threw in their proverbial white towels and cried for “Mercy!”  As the stock market continues to build a solid foundation, it will provide a strong launching pad for many companies, especially those that pay dividends.

 

Given how low Treasury yields have become, income investors should flock back to the stock market, where even the indices are yielding more than 10- and 30-year Treasuries.  Now is the time to focus on companies with solid sales and earnings. We have our eyes glued to additional opportunities in this space.

 

THREATS

One of the greatest threats to the markets and economy right now is deflation, which is the reduction of the general level of prices in an economy.

 

In the first quarter of 2020, almost all commodity prices fell dramatically:

Source: Ycharts

Oil has been the greatest concern. In just two trading days, alone, crude oil prices dropped 40%, going from $50 per barrel, down to $30 per barrel. The initial drop started with a price war between Saudi Arabia and Russia.  The price war, combined with crashing demand due to the fallout created by COVID-19, have oil prices “on the ropes.”

 

Deflation is a serious enemy to any economy. As prices fall, production slows (no one wants to make product, if they can’t make enough money selling it) and inventories get liquidated (companies just sell what they have left, instead of making more). With less new production, unemployment increases (no need for a full workforce).  Less in the workforce means even less demand for the products that do exist (can only buy essentials when you are out of work), which leads to even less production.  The cycle repeats and creates a downward spiral leading to severe economic damage. Economists and central banks are trained to fight deflation. However, with key interest rates around the globe, already near zero or in negative territory, central banks have limited options left to fight off rising deflationary pressures.

 

The main weapon to fight deflation will be the resumption of economic activity. Once COVID-19 restrictions are lifted, stocks, commodities and real estate should be re-inflated. Low energy prices and interest rates will be a boon for consumers and businesses, especially in the residential real estate sector.  Home sales should resume their uptick with near record low mortgage rates.

 

Bottom Line

Given all the data, we are still confident in America’s future and the future of those invested in the broader markets. Despite many challenges and threats to our economy, America is resilient.  It has survived previous pandemics, wars, financial crises, and terrorist attacks. This time is no different. We have been presented with a great opportunity for those who have patience and the ability to take a short-term risk for a long-term reward.

 

With the 10-year Treasury yield near 0.8% and the 30-year Treasury yield under 1.4%, the Dow and S&P 500 both provide much higher yields for investors. Any time these stock indices yield more than Treasuries, stocks historically have been very attractively priced. Today could represent one of the best buying opportunities in decades.  Once COVID-19 is behind us, pent up economic demand should help the United States resume its strong economic growth and leadership!

 

Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc.(APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purposes of avoiding penalties that may be imposed by law. Each tax payer should seek tax, legal or accounting advice from a tax professional based on his/her individual circumstances.
This material is for informational purposes only. Neither APFS nor its Representatives provide tax, legal or accounting advice. Please consult your own tax, legal or accounting professional before making any decisions. Information has been obtained from sources believed to be reliable and are subject to change without notification. The information presented is provided for informational purposes only and not to be construed as a recommendation or solicitation. Investors must make their own determination as to the appropriateness of an investment or strategy based on their specific investment objectives, financial status and risk tolerance. Past performance is not an indication of future results. Investments involve risk and the possible loss of principal.

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