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After making a record high on February 19, 2020, the equity markets have since fallen by as much as 35%. This decline into a bear market has occurred at the fastest pace in history. New records for volatility have been made with the average daily price change of 5.2% during March exceeding the previous record set during the Great Depression. Even investments traditionally considered “safe havens” experienced declines as investors sought to raise cash or were forced to meet margin calls.

Unlike events typically associated with past bear markets, this market decline has been due to an unexpected public health crisis. The Covid-19 virus currently has no vaccine and given the risk it poses to the lives of their constituents, governments across the globe have responded by effectively shutting down their economies. Equity and fixed income markets rapidly declined as a result, perversely serving as a vigilante to fiscal and monetary policy makers. The Cares Act was promptly passed with rare bipartisan support and will provide $2+ trillion of stimulus with more likely to follow. The Federal Reserve cut interest rates to zero and by increasing its balance sheet to more than $5 trillion demonstrated a willingness to go to infinity and beyond with quantitative easing, stabilizing the investment grade credit markets in the process. Economic data will become significantly worse in the short-term, already unemployment claims increased to approximately 10 million in the U.S. during the two-week period ending of March 29th. Through no fault of their own, many will now be without a paycheck indefinitely while their ongoing financial obligations including rent, car payments and utilities remain. The Cares Act will help to bridge some financial obligations but very few people or businesses can withstand zero revenues for any extended length of time. A global recession now seems certain. However, these monetary and fiscal policy efforts will help to meaningfully dampen its depth and duration.

Due to the Fed’s efforts, the interest rate on the 10-year U.S. Treasury Note is currently 0.67% which is the equivalent to buying a stock at 150 times earnings that guarantees no growth over the next ten years. Whereas a $5 million portfolio of municipal bonds could have generated $350,000 of tax-exempt income annually in 1990, today it takes over $17.5 million to generate this amount. Artificially low interest rates can cause distortions and encourage excessive risk taking. Many investors that would prefer to own bonds can no longer “afford” them and the 2.1% dividend yield on the S&P 500 Index currently makes stocks seem relatively attractive to income seeking investors. Low rates have also incentivized many corporations to increase their debt levels. During the past decade, the investment grade corporate bond market nearly doubled to $6 trillion, its highest level ever relative to GDP and approximately half of this amount is rated BBB or one level above non-investment grade. The longer the global economy remains closed, an increasing number of companies will become financially challenged with debt they may have been able to comfortably service during normal times. Capitalism without bankruptcy has been likened to religion without hell and many have already started feeling some heat.

Economic and market downturns are never pleasant but as John Stuart Mill once said, the seeds of each economic boom are sown during the preceding crisis.

Ted E. Furniss – April 3, 2020

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