Written by Michael Forrester – Founder, President, and CIO of High Note Wealth
The fun continues! For anyone keeping score at home, it was a rough day in the US stock market. The last two weeks have been a roller coaster of ups and downs, but today we saw the “ride closed for repairs” sign. Perhaps the more appropriate analogy is we got the family ready to go and loaded up in the car on the way to the amusement park, only to find it closed due to an oil spill. More on the “oil spill” below. In terms of today’s action, this is expected as volatility in the markets typically leads to more volatility. That sounds overly simplistic, I know, but we do typically see extended periods of quiet with pockets of loud volatility along the way. In the moment it can feel scary and like it is here to stay. We understand that it can be uncomfortable. The logical question that comes to mind is, “what needs to happen for it to stop?”. This is a great question – a question that the financial media spent all day discussing ad nauseam with lots of ideas but no consensus. Why? Because nobody really knows. Many have opinions, but what we normally see is that there isn’t a nice, clean explanation for the return to normal. It just happens. Some like to refer to it as “full capitulation” or “markets clearing” but those are more or less fancy ways of commenting on the market without offering a real explanation of what has turned the tide.
As we mentioned in our last note, the market moving all over the place does provide some opportunities that we can take advantage of, but more importantly provides a great reminder of why we recommend having insulation with our investments. What’s the insulation? First, it’s not being 100% exposed to stocks. This is an obvious one. We certainly do want exposure to stocks for growth but not for any money we are going to need to spend within a couple of years (read: financial planning). This strategy allows us to concern ourselves with where the stocks will be on March 9, 2022, not today. The other big pieces of insulation are having cash in accounts and an appropriate amount of bonds. We were cash heavy going into this mess which has been very helpful. With interest rates going down to record levels, our bonds have not just provided insulation but also very productive returns. It’s easy to skimp on the insulation when markets are making all-time highs, but it plays a very important role today.
In terms of how we are handling the situation, we are continuing the work of gently moving cash into the market where appropriate, harvesting tax losses and positioning the portfolios for the continued volatility that we expect. To get a little more specific, we continue to lean on the technology and health care sectors with a focus on companies that generate high levels of free cash-flow. Future earnings will be questionable while the COVID-19 virus works through the global financial markets but there are plenty of quality companies that are holding strong and could come out of this period even stronger. We aren’t calling a bottom or making bets on when this period will end, but rather doing everything that we can today as we know this too shall pass.
If you are not reading on, our advice is to avoid the noise, stay calm and check in with us for any reason. We are here to help!
Oil Trade:
The drama of today’s pullback was not about cases of COVID-19 or fears of a pandemic. It’s certainly part of the narrative but oil took center stage over the weekend. Late last week, OPEC had a meeting about reducing oil output given the slow down in demand (Chinese factories have not been consuming as much with the complications of dealing with the coronavirus). Typically, OPEC will slow production anytime demand slips to keep prices high. To do this, they need cooperation from major producer and non-OPEC member, Russia. This has worked in the past, but this time Putin said “no”. In response, Saudi Arabia said they are going to increase production and, bam, we have oil prices plummeting on over-supply concerns. Last evening, we saw global oil prices slip as much as 35% – a significant move. This automatically puts oil companies and all the services in the oil business under pressure. The oil stocks got absolutely crushed which lead the overall market slump today. These companies tend to have a lot of debt which is a concern. This has happened in the past. Usually cooler heads prevail as oil prices this low ultimately hurt all OPEC countries and Russia. The long-term future of oil is still up for debate, but we have been under-weight in anything oil related, particularly in the bonds that the oil companies issue. This was a very nice place to be today.
Couple of Optimistic Observations:
- Airline Stocks: The airline stocks performed well in a down market on Friday. With the slow down in travel, airline companies have been taking it on the chin (American Airlines lost over 50% of its value in less than a month). While the stock market was down on Friday, the airlines seemed to find a bottom and had a positive return. In a total panic sell off, we don’t see sectors finding a bottom like that.
- Jobs Report: The February jobs report was extremely strong. While it can be dismissed as “history”, it does speak to how strong the US economy was before the concerns of the virus appeared.
- Bond Market: The bond market continues to behave. I’ve mentioned before that interest rates going down in rapid fashion indicates that sellers of stocks are putting their money in bonds and not under their mattresses as they do in a panic. This trend is continuing. We have seen the price difference between company bonds and US bonds increasing (called “credit spreads”) in an orderly fashion. This is an expected increase, but at times in the past it hasn’t been as orderly as we’re currently experiencing.
- Hedge Funds Behaving: With increased volatility there is always a concern that a hedge fund will get over-levered and blow up causing all sorts of fall out. I spoke to someone at a large trading desk who said hedge funds haven’t been in forced selling mode which is good news.
Bond Chart: As mentioned above, bonds provide insulation when stocks are going down. Here is the year-to-date return chart of a bond ETF that we own. This is a solid return that offsets the drop in stocks and also provides “dry powder” for rebalancing the portfolios.
Mondays: The majority of large market pullbacks have occurred on Mondays. Interesting to note, if nothing else.
After Mondays: Here are all the historically big market drops on Mondays. The table shows the returns following a big Monday sale. History doesn’t necessarily repeat itself, but it does put today into context.
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