April 2020 Letter
First and foremost, we hope this quarter’s letter finds you and your family healthy and safe! This quarter, we had intended to bring you part two of our lifecycle financial planning series with tips and advice for our midlife readers. Look for it later this summer. Also different this quarter, we are preparing our letter from home as all Covington employees are safely working remotely for the time being. Rest assured that all of our personnel have full functionality and are ready to respond to your needs and questions. Given the enormity of the coronavirus global pandemic, we wanted to offer our perspective on the response (so far) to the virus. For the limited scope of this letter, we’ll look at the societal response, the Federal government’s fiscal attempt to get to the other side, and the unprecedented measures taken by the Federal Reserve. And lastly, we’ll try to put the market’s dramatic decline in perspective.
Undoubtedly, 2020 will forever be known as the year of “social distancing.” Local leaders around the world, attempting to suppress the spread of the virus, have closed large swaths of the economy. Today, closures range from Los Angeles County beaches to New York Broadway theaters, and every indoor public dining room in between. No one can say for sure when citizens will feel comfortable in large crowds again, but our expectation is some behaviors will change and some trends that were already underway will likely accelerate on the other side. For instance, prior to the pandemic, the streaming wars were just starting. New streaming options were being launched with the aim of offering competitive alternatives to Netflix. Meanwhile, movie theater attendance was in a gradual decline and the pace of “cord cutting” was picking up. Video gaming, with esports and team sports were also already growing rapidly. But, it’s not just fun and games at home. Healthcare, long a digital laggard, has finally gotten serious with telehealth solutions that keep people out of clinics if a physical visit isn’t needed. After sheltering in home for several weeks, it seems likely these trends accelerate, with video cord cutting being offset by increased demand for higher speed broadband connections to accommodate streaming and gaming options.
In most parts of the country, closing of non-essential retail was also ordered to reduce gatherings of people. Unfortunately, this will likely accelerate the trend of closing brick and mortar retail doors. Online retailers, led by Amazon, were already steadily taking share from traditional outlets. When the pandemic is clear, undoubtedly there will be pent up demand for shopping, but longer term, companies that have made and continue to make the investments necessary to execute an omni-channel approach to retail are likely to thrive. Bars and restaurants (that survive) should snap back, again from pent up demand and the need to socialize. Theme parks, cruises, and air travel are less certain and likely dependent on consumer confidence that effective testing, treatments, and vaccines are discovered.
2020 will also be known for WFH (work from home). The Bureau of Labor Statistics (BLS) estimated that as of 2018, 29% of the workforce, or 42 million people, could work from home, and about 19% were in fact receiving compensation for work at home. During the current emergency, the BLS estimates that as many as 71 million people could work from home. Advances in broadband speed, network security, and video conferencing have greatly enabled workers to be more productive and interactive out of their homes. Workers are now able to function as teams remotely through video conferencing. Additionally, there are now various platforms that facilitate electronic signatures and contract management. It seems likely that after a sudden, successful, nationwide test of our telecommuting capabilities, more Americans will continue to perform at least some of their work duties from home. But, sadly, millions of Americans won’t be able to work from home during the emergency, their jobs may be lost, and they’ll need help.
Our Government CARES
The federal government has intervened in a bipartisan, massive way with three rounds (so far) of legislation, all with the aim of coping with the virus and providing some sort of bridge from one side of the economic shutdown to the other. The latest round of legislation, passed and signed into law in late March is the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act. Cornerstone Macro estimates the bill will inject over $2.5 trillion into the economy this year. That’s a significant boost to our $21 trillion economy. The nearby table highlights the major priorities of the bill and the expected costs. The bill’s underlying intent is to get money to people and businesses that may need it.
First off, checks are on the way. The government is sending $1,200 per adult and $500 per child, with a phase out starting at incomes exceeding $75,000 per individual. This means an average family of four, with income up to $150,000, will receive $3,400. Other highlights to the bill include temporary rules pertaining to IRAs. Importantly, required minimum distributions (RMDs) are waived for the 2020 tax year. Please check with your accountant to determine the right strategy going forward and whether distributions already taken can and should be reinvested.
The new law also includes provisions allowing people under 59½ to tap IRAs for virus related expenses, up to $100,000, penalty free. The distribution is still taxable, but the tax can be spread out over three years and the money can be put back into the account. IRA holders over 59½ are also eligible for the tax deferment. Additionally, the amount that can be borrowed from company plans has been increased to the lesser of $100,000 or 100% of the plan balance.
More broadly, the bill aims to help businesses, big and small. For small businesses, the bill includes emergency grants of up to $10,000 and forgivable loans up to $10 million to cover payroll. There is also relief for existing small business administration (SBA) loans. For big business, the bill includes $500 billion in loans, including nearly $60 billion targeted for the airlines. Companies taking these loans will be barred from share repurchase until one year following repayment and will be subject to additional reporting requirements. Additionally, the bill creates a special inspector general to oversee the program. Lastly, for all businesses, the bill includes payroll tax credits.
Led by Chairman Jerome Powell, the Federal Reserve (Fed) has also taken unprecedented steps to mitigate the virus’ impact on financial markets. Over the past month or so the Fed has dusted off its playbook from the financial crisis and added in a couple of Tom Brady’s Super Bowl plays as well. In times of crisis, when everyone in financial markets is heading toward the door at the same time, markets get gummed up and liquidity disappears. The following timeline highlights the Fed’s actions to ensure markets function properly:
- February 28; The Federal Reserve issues a statement noting it is monitoring changing economic developments and is prepared to use its tools to support the economy.
- March 3; At an unscheduled meeting, the Fed lowers the Federal Funds Rate (FFR) by 50 basis points, to 1-1¼%.
- March 15; At a second unscheduled meeting, the Fed cuts the FFR to zero, encourages banks to use its discount window for emergency borrowing, and coordinates with other central banks to ensure dollar liquidity.
- March 16; The Fed lowers the discount rate paid by banks to ¼%.
- March 17; The Fed announces a commercial paper funding facility to provide liquidity to the short term corporate borrowing markets.
- March 18; The Fed announces the establishment of a money market liquidity facility to ensure money market funds can meet demands for redemptions.
- March 19; The Fed again coordinates with other central banks to ensure U.S. dollar liquidity around the world.
- March 20; The Fed takes steps to ensure liquidity in the municipal bond market.
- March 23; The Fed announces new measures including intervention in the mortgage backed securities (MBS) market and new facilities to assist the corporate debt markets. Additionally, money market fund and commercial paper facilities were expanded.
Indeed, it was a busy month for the Fed, including other technical steps too numerous and nuanced to list here. By the end of the month, broadly speaking, interest rates were lower, indicating markets were functioning with needed liquidity.
As of this writing, we don’t know exactly where we’re headed over the next few months and how the virus will run its course. These are undoubtedly scary times and there will be talk about “testing” the March lows, but history tells us times like this have eventually provided the most profitable buying opportunities. In fact, since World War II the stock market has experienced seven quarterly declines of 15% or more, with the average being down 21%. In this year’s first quarter, the stock market was down 20%. In all seven of the previous occurrences, stocks were higher two quarters, three quarters, four quarters, and eight quarters later, growing at a rate two times the long-term average. This is why over the next few weeks or months it is important to consider rebalancing. It was the right strategy on the way up and equally valid on the way down. Successful long-term investing often requires reallocating a portion of the portfolio to those asset classes that may be out of favor, but at reduced prices.
Rest assured, our equity and fixed income teams have been scrutinizing earnings reports, cash flow statements, and most importantly, balance sheets to ensure we make investments that can ride out the storm. Stay healthy and safe!
COVINGTON CAPITAL MANAGEMENT
601 South Figueroa Street, Suite 2000
Los Angeles, CA 90017 | 213.629.7500