Stone Monthly Market Commentary & Forecast – March 31, 2020
Black Swans are surprises that change the current norm and can radicalize conventional thinking, and COVID-19 qualifies as a Black Swan big enough for the history books. The markets received the full-fledged details of the potential economic and corporate toll from the pandemic and it was not pretty. The talk was no longer about whether we were going to enter a recession, but rather how long will it be? Governments globally imposed radical conditions as to how people and economies can function, aggressively requesting social distancing with people staying at home and thus shutting down economic activity. The result is that airplanes are grounded, streets are empty, and factories are shut – this is not the definition of good times. At least one-quarter of the US economy has suddenly gone idle amidst the coronavirus pandemic. This is an unprecedented shutdown of commerce that has never occurred on such a grand scale in our lifetime.
After a 5% retrenchment in Q1 GDP, estimates for a Q2 GDP contraction of 25% had markets on edge for the entire month of March. To comply with government lockdowns, global corporations created a tsunami of job losses when they shuttered manufacturing and retail stores around the world, resulting in a wave of job losses. US employment figures, which showed a staggering rise in the initial unemployment claims number of 6.65 million, we estimate are now in the neighbourhood of 12-14% plus.
The consensus opinion from economists and analysts is that the data will get worse before it gets better, so at Stone we are bracing for more negative economic news in April. This is a huge, extraordinary hit to the North American economies since they are driven by consumer activity. The ensuing March market volatility resulted in the S&P 500 fluctuating daily by an average of 5.2% for the entire month. This is truly a remarkable figure.
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Recapping the TSX market activity, for the second consecutive month every sector of the TSX was down for the month of March. Leading the way down were the heavily weighted financials sector down 18.6%, real estate down 27.6% and energy down 47.8%. There was no place to hide as defensive sectors such as gold, consumer staples and utilities were also down. Gold and consumer staples both declined 5.4%, and utilities 7.2%. This is indicative of a fragile market in panic mode, seeking liquidity at any expense. Investors were forced to liquidate stocks to offset losses, satisfy margin calls and to deal with their emotional fears.
Without contacting Captain Obvious, we asked ourselves what should we be doing? For the team at Stone the answer was to stick to our knitting, focus on preserving our client capital, build a cash reserve for future opportunities and own portfolio insurance to protect from future market volatility. Our total return portfolios had been overweight US financials with a minimal exposure to energy and REITs which we liquidated, raising our cash balances in the rage of 13-19%. Within our mutual funds we completed a full review of our dividend-paying investments seeking to sell companies that would have a risk of cutting their dividend. Within our growth mandate we were sellers of any companies we believe cannot sustain revenue growth once the North American economies attempt to return to normal. The objective for our growth and total return mandates is not to be defensive but to be prudent, seeking to preserve capital and have money to purchase quality businesses that provide the opportunity for growth revenues and/or dividends.
We believe that when the market’s recent panic selling behaviour was irrational, the best course of action was to stand aside and let the panic selling run its course. Late in March we began to see an effort for the market to find a foundation and stability, and we raised cash by selling into strength. Our day-to-day work now is to find clarity about what future earnings are going to look like and to be comfortable with the price we should be paying to own a business.
At Stone we believe patience is a virtue at this time. Looking forward we expect to see a strong market rally followed by a sell off which is when we would want to be buyers of outstanding businesses.
I’m constantly fascinated by the market’s compulsive behaviour to monitor the US Federal Reserve’s statements and action. Since 2008 the Fed’s strategy has been very clear. Where real estate is about location, location, location, the Fed is about liquidity, liquidity, liquidity. In the 1930s, the then-equivalent to the Fed chose to tighten monetary policy. This is believed by historians of that era, such as former head of the Fed, Ben Bernanke, to have been the catalyst for an extended depression. In the beginning of the 2007-08 global financial crisis, Bernanke chose to not repeat the events of the 1930s and began what we now call “QE”, Quantitative Easing. The arrival of the COVID-19 Black Swan has begun QE4 and what concerns us is the Fed’s willingness to acquire higher-risk assets for their balance sheet in an effort to provide liquidity.
This link to Visual Capitalist’s piece on The Fed’s Balance Sheet: The Other Exponential Curve is an excellent historical review of the Fed’s actions, and can provide meaningful insight into the current situation.
We use our proprietary investment process daily and in volatile market conditions such as these, we seek to ensure that we can manage downside risk and adjust the portfolio accordingly while seeking to achieve our long-term investment goals.
We remain invested and are committed to companies that provide revenue growth, improving free cash flow and higher earnings per share. We are active portfolio managers with a disciplined investment process including the implementation of various risk management tools to benefit our investors.
Stone Asset Management Limited
Richard G. Stone, Chief Investment Officer