Capital Market Comment
April 13, 2020
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
As we enter the period of greatest economic impact from the government’s response to COVID-19, the data will show unprecedented deterioration in business conditions. Even if we begin to emerge from the shutdown (ever so gradually), the data for April and May will show a decline in GDP that some suggest will be as high as a 30% annual rate in Q2 and unemployment reaching 15-20%. What does this all mean?
Will it be enduring or is it a shock-induced response that will improve dramatically when the government’s constraints are lifted? Has the market’s precipitous fall discounted the economic fallout, and is it now looking beyond that period, or will we experience dislocation when reality sets in? It is too soon to tell, but the magnitude of the fiscal and monetary response would suggest a recovery would ensue. What investors do know is that the level of fiscal and monetary stimulus is unprecedented, and the speed of the response is remarkable.
Furthermore, steps are already being taken. Another bill is being proposed to provide additional funds for small businesses and consideration is being given to additional safety-net funding. Moreover, on Thursday the Federal Reserve announced a $2.3 trillion program to aid businesses and municipalities. It includes:
1) a $500 billion municipal liquidity facility to lend to states and municipalities;
2) the “Main Street Lending Program” to provide $600 billion in loans to small- and mid-size companies;
3) an expansion of the size and scope of the primary and secondary market corporate credit facilities and the term asset-backed securities loan facility, resulting in $850 billion in available credit;
4) and the start of the Paycheck Protection Program liquidity facility.
The equity market has exhibited remarkable resiliency off the lows reached on March 23, 2020. On that day, it appeared that indiscriminate selling took place. Stocks were declining without regard to sector, fundamentals, or technicals. It was the psychology of a panic.
Over the coming weeks, as we move into earnings season, the damage the shutdown has caused public and private companies will become apparent. Many firms have already begun to provide insight and updates on the effect of the virus and the changing conditions around the globe (Starbucks, McDonald’s, and others). This path seems to be the likely one that many companies will follow. The market has greeted this development favorably thus far. It is interesting to note the behavior of some large cap stocks from their respective lows in March. Apple, Amazon, Google, Facebook, and Microsoft had impressive rebounds, but many cyclicals recovered more – a move from the precipice.
The “pandemic panic” and the accompanying capitulation that appeared to culminate at that time highlights an important thought on investing. Recovery returns can only be achieved if one remains invested. Market timing has proven to be an unsuccessful strategy. As an example, over the last 20 years ending March 26, the S&P yielded a 10.05% annualized return. However, if you missed 20 of the best days, you generated a -3.17% loss. As always, no one knows when those extraordinary days will occur, but being engaged allows the investor to participate. The major market averages all experiencing an over 7% gain on April 6 is one such example. The week ending April 9 was also exceptional.
The gain from the market low on March 23, and the speed of the rebound (similar to the descent), may well reflect in part a pulling back from the brink and a realization that the worst-case scenario (collapse) would not occur. As in 2008 and 2009, swift government response began to restore the functioning of the credit markets, and eased fears. Unlike 2008, the magnitude, speed, and bipartisan support is unmatched. Also, in 2008, the banks were part of the problem; today they are part of the solution.
The yield differential between “junk” bonds and high-quality Treasury bonds, and the behavior of the St. Louis Fed’s Financial Stress Index, show the difference between the two periods.
In 2008, the differential ranged between 1600 – 1700 basis points. By contrast, thus far in 2020, the differential peaked at 1100 before falling to under 800.
The stress index peaked at over 9+ in 2008. In 2020 it peaked at under 6 and now stands at 2.8. The additional steps that have been taken with the new $2.3 trillion Fed Program should further reduce financial stress and create more orderly markets.
The next phase of the equity market is likely to be more targeted and discerning. Investors are likely to focus increasingly upon fundamentals, distinguishing between the sectors that are effectively managing through the cycle, and those that continue to struggle. The earning season should provide greater insight into this phase.
In our judgment, the market performance is going to be less about who will survive and more about the quality of the balance sheet and the growth recovery prospects. The speed of the rebound will become increasingly important, and sector and stock selection will dominate.
If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or firstname.lastname@example.org
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or email@example.com
Mastrapasqua Asset Management, Inc. does business as M Capital Advisors.
104 Woodmont Boulevard, Suite 320
Nashville, TN 37205
200 Concord Plaza, Suite 500
San Antonio, TX 78216
© 2020 Mastrapasqua Asset Management, Inc. All rights reserved.
The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.