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7am Saturday

March 21, 2020

Good morning! Well, what can I say? I guess I’m just glad it’s Saturday. The past week was clearly one of the more difficult week’s of my career. I will write about some of it today, but there’s no way I could capture everything in a brief email as it seemed like I lived a month over the past week!

Market Update

+ The S&P 500 fell 15% this week, it’s worst weekly performance since October, 2008. The S&P 500 closed the week at 2304.92, it’s lowest level since February 2017. The index is now down 32% from its February 19th high.
The S&P 500 also closed below the “Christmas Line” of 2,351, the bottom of the 2018 correction reached on Christmas Eve 2018.
Here’s how the week went for the S&P 500…

  • Monday: -11.98%
  • Tuesday: +6.00%
  • Wednesday: -5.18
  • Thursday: +0.47%
  • Friday: -4.34%

…overall, the S&P 500 finished this week down -15.01%.
+ All three major U.S. stock market indices are now more than 30% below their all time highs:

  • S&P 500: -32%
  • Dow Jones Industrial Average: -35%
  • NASDAQ Composite: -30%

Understanding the Health Threat of COVID-19

Here’s a video that documents what’s happening in one town in Italy. Italians want to send a warning to the rest of the world. (Warning: There are some disturbing scenes of some critically ill people in this video.)
It’s time for our nation to take this threat seriously. I think we’ve made a lot of progress over the past 10 days, but I also see pockets of the country that have yet to go on lockdown. I live in Ohio, and we are fortunate to have a Governor who has been at the front of the curve. He has made some unpopular decisions. And that’s why I admire his leadership. He is leaning into the facts. COVID-19 is a deadly disease, and we must get in front of it to “flatten the curve”.
Do I like shutting businesses down, cancelling events, and sheltering at home? No! But, I’m afraid it’s the only way we can stop the outbreak from overtaking small towns like Bluftton, Ohio (population 4,400) which is just down the road from me.
Check out this video that Dr. Ross Kauffman, an epidemiologist from Bluffton, created this video to clearly show why it’s so important to take action now by practicing social distancing and sheltering to flatten the curve.
If Ohio is on lockdown why not ask the whole country to unite and do this together? Let’s go all in and beat this!
I get frustrated when I see that here in Ohio we are taking the right steps to get in front of this, but down in Florida spring breakers are mocking the whole thing. Drinking Coronas on the beach and ignoring the warnings. Let’s unite as a nation and go on lockdown for 30 days and put this whole thing behind us!
Even Elon Musk, CEO of Tesla, intitially downplayed COVID-19, but is now willing to manufacture ventilators in Tesla’s factories if there is a shortage (very likely).

Understanding the Economic Impact of COVID-19

If you’re in a state like Ohio you have probably seen by now the first hand impact that lockdowns will have on the economy. You can’t shut everything down for too long without seeing a big hit to economic growth.
Billionaire investor, Bill Ackman, was on CNBC Wednesday morning with his outlook for the economy. He really painted a worst case scenario. He’s asking President Trump to shut down the nation for 30 days. Note that Mr. Ackman does believe that we are headed down the right path, so he’s actually buying stocks right now because he believes we will ultimately do the right things to beat this virus.
If you want to understand the math behind the exponential growth of the coronavirus then read this. Or, I can simplify it for you from the following table on my Bloomberg terminal:

  • 15,973 confirmed cases in the U.S. (as of Friday)
  • Over the past 5 days the change in the number of cases has been increasing by 43% per day.
  • So, the number of cases 5 days ago was just 3,037.
  • We have had not one, but more than two doubles in the number of cases over the past 5 days.
  • At this rate, 7 days from now, we will have over 195,000 cases in the US.

Here’s a look at where we are as of late Friday night:

So, clearly the pandemic is spreading throughout our own country. The economic impact will be felt for months to come.

Passive Management Will Fail You in Bear Markets

Over the past decade there has been a huge shift to passive investment portfolios. So many active managers have underperformed the benchmark that investors have decided it’s no longer worth it to try to “beat the market”. Investors have concluded they are better off owning the whole market rather than trying to beat a benchmark. It’s simpler and easier to just own the benchmark and get the average return of the stock market. But is that the best approach?
For example, do you really want to own the S&P 500 Index fund in this market? You will own all 500 stocks in the index. It doesn’t matter how strong they are financially, what events are hurting their business, or whether their business has a growing market share or a declining market share. You just simply own all 500 stocks that some committee at Standard and Poors decided to include in the index.
Now think about that. Do you reallly want to be an investor in Boeing stock during a time like this? First, the company had trouble with it’s 737 MAX airplane which had production suspended in March 2019 after two new airplanes crashed within five months of each other. Now, Boeing is struggling as airlines around the world have grounded flights due to COVID-19 related travel bans. As I right this, I see they have suspended their dividend. Now, as an investor in an S&P 500 index fund you automatically own Boeing stock. But, if you are an active investor, or if you invest with an active manager, you don’t have to own the stock. Please note that this is not a recommendation for you to buy or sell the stock. I’m just making the point that you may, or may not, want to own a company like Boeing in your portfolio. (I do have an opinion, and if you are a client you know what it is.?)
Now, more than anytime over the last decade, you want to understand every company in your portfolio. You want to know if the company is poised to weather this economic downturn, or if it is at risk of losing massive economic value.
Seeing how many people followed the trend into passive portfolio management I’ve concluded this may be an unpopular opinion. I know I have at least one prominent investor who sees the same thing I’m seeing. Last summer, The Big Short investor, Michael Burry, called a bubble in passive investing.

Our Monday Moves

Over the past weekend, I put together a 14-page research report titled, Bear Market Brain Dump – Weekend #1. The week prior we officially entered a bear market. The reality around the COVID-19 outbreak began to set in, and the data wasn’t looking good. Being in Ohio and seeing the state shut down events and businesses before others in the nation enabled us to see the economic impact first hand.
+ The key points of my research that I shared with my team on Sunday were:

  • The coronavirus pandemic and the underlying economic consequences are changing rapidly. Wherever you look economic activity is shutting down, and I expect it to remain shut down for at least the next 4 weeks. Essentially the only retail left open will likely be supermarkets, grocery stores, pharmacies, gas stations, and take-out food. We are likely witnessing the biggest economic demand shock in the shortest period of time in our lives.
  • Because current events are unprecedented for Americans, it will fuel the type of uncertainty, fear and feeling of powerlessness that results in either total paralysis or massive over-reactions.
  • Being the first “social media pandemic” of our times I believe that the over-reactions will be much greater than most expect.
  • Being in Ohio we may be ahead of the crisis curve as Ohio’s governor seems to be leading the way. NYC seems to be right behind us. Talking to a friend in Georgia it seems other parts of the country haven’t yet taken the measures we have. I think they will within the next week.
  • I don’t expect the V-shaped recovery some are calling for. Yes, when the recovery happens, I think it will be a dramatic snapback, but I also think the bottom of the crisis could look more like a “U” than a “V” and hopefully not an “L”.
  • We are an active firm, and I feel it’s our responsibility to stay ahead of the curve. Just as our State Governor DeWine is working to stay ahead of it and “flatten the curve” from a health side, I feel the responsibility to take any action we can to “flatten the financial impact” and avoid a major drawdown to our client’s portfolios.

+ And then the conclusion:
“This report is not meant to be alarmist, but realistic. You know I’m normally bullish on the economy and stock market. While in the near-term I have turned bearish, I’m still optimistic long-term. Once we get beyond the crisis there could be some very good economic times ahead. There will be some amazing opportunities. Everything that’s happening, and my outlook for some tough times ahead is TEMPORARY. Everything will reopen. This is not the end of days. The U.S. is not going out of business. When life as we know it changes as fast as it has in the past week it’s hard to remember that. Better days are ahead!”
+ Bottom line: I expected things to get worse before they get better. But, yes, eventually we will pull through this just as we always do.
So, we called an early morning meeting last Monday to discuss the data and determine our approach as a firm. By the time the market opened we had made our decision to take a defensive approach in our client portfolios and trades were underway.
Here is the video we sent to our clients Monday evening.

An Unpopular Approach

Most financial advisors are continuing to recommend that clients ride out the downtrend. While that’s not necessarily bad advice for a long-term investor, I do believe that it is possible to capture less downside during major bear markets while still participating on the upside once the recovery begins.
I say this from our own firm’s experience in 2008. That year was the only other year in the history of our firm where we took a defensive position to hedge the downside while waiting for the market to give us some signs that an uptrend was coming.
We always tell our clients to assume that we are going to be fully invested at all times and that they should expect their portfolio will track the ups and downs of the markets. However, if we have conviction that things will get worse we will take some steps to hedge the downside. And that’s exactly what we did this past Monday.
The data we’ve continued to receive throughout the week validates our thesis. However, it is important to know that markets will begin to bottom and rebound well before the obvious signs are bottoming. So, as a result we’ve been hard at work all week monitoring our dashboard of indicators that we will be watching to know when to go back to playing offense in our client portfolios.
This is not a strategy I recommend to individual investors. We have tools that most individual investors don’t have. We have a whole team monitoring the situation, and we have the ability to act quickly. In short, we do this for a living, and it’s our full-time job, so we are equipped for this.
Only time will tell if our approach works in this bear market. If you’re interested in following our thinking then stay tuned. We have an exciting announcement coming next week about an opportunity for you to follow our thinking a bit more closely.

Some Positive News

One thing I hope to do throughout this pandemic is share some of the positive news I’m hearing:

  1. The first human trial is underway for a COVID-19 vaccine. The testing process is moving along at an unprecendented pace.
  2. More than 100 public utilities have agreed to keep water flowing. The companies will not cut off water to homes that fail to pay their water bills during the coronavirus crisis.
  3. We may see a 10-minute testing kit that could be a game changer. A U.K.-based company and a Senegalese research institute are developing 10-minute coronavirus testing kits that can be manufactured for $1.
  4. Hydroxychloroquine & Azithromycin as a COVID-19 treatment may be the gamechanger we are looking for! See the chart below, which shows the combination of an antimalarial & an antibiotic and the outstanding successful results from this combination of drugs:

Source: Gautret et al., 2020.

Your Weekend Resources

The Coronavirus (COVID-19) Pandemic & Bear Market Updates – This is a curated list of all the client updates our firm has published. This page will continue to be updated throughout the bear market. Bookmark this page and check it often as we intend to frequently communicate our thoughts to current clients and potential clients.
Wesbury 101: The Coronavirus Contraction – Here’s a great video from Brian Wesbury with a more bullish view.

As I said last week, I continue to believe that the next 3 weeks are going to be unlike anything we’ve experienced in modern history. It’s likely to stay difficult for some time to come, but just as it has every time in the past, the market will eventually bounce back from this. It may not be quick, but eventually we’ll get there!
Take care of yourself and enjoy the extra family time. Thanks for reading!
Have a great weekend,
↩️ PS – If anytime you get an email from me and you want to share a comment or ask a question, simply hit ‘reply.’ I read every email, and try my best to respond.
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