Research Note: Covid-19 and Global Response - March 15, 2020

This note lays out my view of the current investment situation, my response to a subscriber who is taking a break from the stock-linked ETFs, and a brief comment about the Focused 15 investment approach.

We are in a period of extremely high uncertainty. Because of the rapidly emerging and expanding Covid-19 pandemic, we are seeing a highly synchronized cessation of economic activity on a global basis. We have not seen this before. In the Global Financial Crisis n 2007-8 for example, we saw different markets around the world react at different times as the extent of the financial system’s woes became more apparent. Red flares of stress occurred every few weeks as another portion of the financial system broke down or another industry was being hit.

The pros of the current environment:
  • The global cessation of economic activity we are seeing is NOT primarily driven by economic failings. Essentially, we are reducing economic activity to prevent the pandemic from claiming many lives. As of just a few weeks ago we knew that the US had low unemployment, interest rates were low, the global economy was healing from a series of trade wars, and, very importantly, we had a reasonably strong financial system. If the reduced economic activity is brief, we stand a good chance of resuming strong economic activity in a few months, which the markets will start to consider very quickly.
  • We have the Global Financial Crisis of 2008 in recent memory. We have institutions and people in place that have looked into the abyss of that financial meltdown and tried many tools until they found success. Today, policy makers (the Fed and its counterparts around the world) have tools and are not afraid to use them. On the fiscal side, Congress should be more responsive than it was in the Global Financial Crisis.
  • We have seen China and South Korea have success in containment and mitigation in the matter of just a few months. We can do that as well. 
The cons:
  • Interest rates were already low by historical standards, making rate reductions a less powerful tool to stimulate economic growth. Yet, as mentioned above, the Fed has many other tools to use.
  • There is uncertainty about the response of Congress (and law makers around the world) regarding fiscal stimulus. This may be addressed in the US by the bill being sent to the Senate on Monday. If that bill is not enough, other bills are very likely to be put forth.
  • There is unfamiliarity among investors about how a non-economically driven market crisis will play out. I suspect this is the major issue. Many investment decisions are made, understandably, based on economic and financial drivers. These include economic growth, earnings growth, valuation, etc. Currently available data related to these measures is viewed by many as no longer relevant to the future. Investors can look at numbers, but they are likely meaningless numbers.
  • I believe that if governments act soon and completely, we can weather the reduced economic activity without excessive (2008-like) damage. I am even optimistic that the actions we have seen over the last week around the world will have that impact. As you know, these views do not influence the algorithms or target weights.

Nonetheless, we have extremely disoriented investors right now. Until we get more data points that let people know the status of the economy, investors and markets are likely to continue to be disoriented and erratic. This is different than the rhythmic tug-of-war between the optimists and pessimists behind the MRI signals we use. During this data vacuum, many investors are selling.

If the Recent Declines Are Too Much

I have spoken with several subscribers this weekend. All have been surprised by the magnitude of the decline, as have I. Most are tolerating the decline. One subscriber sold out of the DJIA-linked ETF “DDM” a week ago and is wondering when to get back in. In this case, I think it prudent to wait for a clearer link between market price moves and the MRI. An important feature of the model portfolios is that we can be aggressive during the rebound in stock prices. This means that stepping out of the market for a while may cause you to miss some of the positive returns of the ultimate rebound but your Focused 15 Investing returns can still be quite strong in the longer term.

Review of Investment Approach

As I do frequently, I reviewed the Market Resilience Indexes and the algorithms this weekend. I am comfortable that the MRI have tracked the resilience shifts over the last months. A weak spot, however, is that the rapid shifts in resilience over the last month could not be accommodated in a weekly trading discipline. I have seen similar periods (Jan 2018, for example) and am contemplating a shift in my communication to subscribers.

I am considering issuing “a loss warning” outside the regular weekly schedule. Over the next few weeks, I will outline what can be done on the occasions where actionable alerts can be issued outside of the normal weekly schedule. On a personal note, I follow the target weights of the publications and have not responded to the loss warnings in the past – I believe the weekly trading discipline helps performance in most environments. Any “loss warning” would be used infrequently and under exceptional conditions.

Please let me know if you have any questions or would like to discuss any of these points.