Week 12 Sitrep

Special note: Our CPA partner, Katie Lomness, provided us a quick update today that we thought worthwhile to pass along. Many will likely see the headline that the IRS and US Treasury have delayed when tax payments are due. Importantly, they have not delayed when tax returns need to be filed (April 15th) or when first quarter estimated tax payments are due (April 15th). If you need assistance with your 2019 return or have further tax questions please feel free to contact Katie’s office directly: info@lomnesscpa.com.

 

The most difficult thing in the middle of a market meltdown is to try and make sense of what causes this volatility – or perhaps trying to understand what started all of this. Is this exclusively due to the concerns over COVID-19 or is there something else we are not aware of? That seemed to be the markets response over the weekend when hearing news of a surprise Fed rate cut of 1%, taking the Fed Funds Rate down to 0-0.25%, and adding more to their planned Quantitative Easing program.1 The markets immediately began a selloff that culminated on Monday, March 16th, with the Dow posting its second worst daily decline in history.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 3/16/20

 

The volatility of the past week was quite discouraging, and it felt like everything was being sold. However, in hindsight, last week saw similar trends as large growth companies went down significantly less than large value companies. The technology, health care and communication services sectors were down the least (slightly more than 5%) while industrials, materials and utilities were down roughly 13-14%. As expected, the energy sector was the hardest hit, down nearly 25%, after the news that Saudi Arabia would be increasing oil output in a showdown with Russia. While portfolios for Engrave clients are still down for the year, we have been able to avoid the worst areas of the market, including small companies and international stocks.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 3/16/20

 

The market decline last week has sent the S&P 500 Index more than 3.5 standard deviations below the 50-day moving averages and has resulted in markets being extremely oversold.2 The last three weeks has recorded the fastest decline from all-time market highs into bear market territory (a 20% decline). We would still classify this as a stock market correction rather than a secular bear market because of the short time frame. The current selloff in stocks is the third over the past five years, albeit in a much quicker time frame.

Source: Bespoke Investment Group, The Bespoke Report, 3/13/20

 

We have often shown that the strength of the market in 2019 was indicated because the majority of stocks were rising during the year. We witnessed the exact opposite last week reflecting how many sellers were in the markets – the most since Christmas Eve of 2018. The breadth (or lack thereof) readings were among the lowest we’ve seen in 30 years.3 This is an important indicator when it comes to determining the bottom of the market correction. The number of stocks falling relative to those rising will start to decline as we see buyers reenter the markets to seek bargains. We are still waiting to see evidence of that happening.

Source: Bespoke Investment Group, The Bespoke Report, 3/6/20

 

There have been many unprecedented moments in the last two weeks as governments around the world respond to the COVID-19 dilemma. The U.S. Federal Reserve, along with most other central banks, has now made two surprise cuts to U.S. interest rates. The most recent announcement by the Fed was summed up well by our good friends at Smith Capital Investors4:

  • Cut Interest Rate to 0-0.25%
  • Purchase at least $500 bln in Treasury securities over the coming months
  • Purchase at least $200 bln of agency mortgage-back securities over the coming months
  • They will also reinvest principal payments from the Fed’s holdings of agency debt and agency mortgage-backed securities into agency mortgage-backed securities
  • Reduce the interest rate on the discount window loan to 0.25%
  • Offer discount window loans for periods of up to 90 days
  • The board reduced the reserve requirement ratios to zero percent effective March 26th, eliminating reserve requirements for thousands of depository institutions
  • Coordinated announcement with Bank of Canada, Bank of England, Bank of Japan, European Central Bank and the Swiss National Bank reducing pricing on dollar swap lines

The Fed announcement was matched by the President and Congress, who have committed to ease regulations on financial institutions to provide liquidity for the markets. We are also expecting a tremendous amount of support in stimulus spending. It is likely the current events will have some negative impact on future economic growth. The good news is that our economy had been recovering in recent months allowing room for the economy to slow a bit. We will watch closely as data becomes available reflecting the adjustment to the U.S. economy.

Source: Bespoke Investment Group, The Bespoke Report, 3/13/20

 

Our market indicators remain in positive mode reflecting how quickly the current correction has affected markets. The long-term indicator uses several factors that measure the markets over multiple months and years. Thus, the current bull market status remains intact and confirms our assumption of a correction. Even though the short-term indicator is positive, the indicator value of “0” confirms that all market sectors have experienced significant distributions. Our study of the supply/demand characteristics for individual asset classes and sector confirms that investors have been reluctant to remove large company asset classes from their portfolio while small- and mid-size asset classes show higher risk scores currently. We have not invested in small or mid cap stocks for our client portfolios since the end of 2018 due to the unfavorable risk/return relationship.

An overlooked area of volatility for most investors has been U.S. Treasury Bonds. The 10-year U.S. Treasury had been falling for the last two years and recently recorded an all-time low yield of 0.31% last Monday, March 9th. Over the last seven trading days, the 10-year bond has risen to 1.08%, a better-than threefold increase! The reports we’ve received say that the trading activity in bonds has been very unusual and many areas of the bond market are difficult to sell over the past week. This is not surprising for lower quality corporate bonds (junk bonds) but is very alarming for U.S. Treasuries. The volatility last week resulted in losses for most high-quality bond funds, including municipals. Again, we’ve avoided the high yield/junk bond category in taxable bond accounts for clients entirely over the last two years due to the unfavorable risks.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 3/16/20

 

Another surprising event over the past week has been the movement in U.S. mortgage rates. We have read about the large influx of refinance applications for homeowners. However, due to the volatility in bonds, we also saw a marked increase in mortgage rates near the end of the week that has carried over to this week.

Source: Bespoke Investment Group, The Bespoke Report, 3/13/20

 

In summary, we are encouraged that the end of the quarter will present an opportunity for markets to move back higher. We have received several calls/emails asking if this is the time to buy more stocks. If your holding time is more than 2-3 years, then this is likely an excellent time to consider adding stocks to a portfolio. We will be sending a separate email newsletter to current clients with specific portfolio results and additional risks we are considering. We are grateful for the patience our client families have shown over the past two weeks – as investment advisers, we always hate to see portfolios go down in value. However, the risk management strategy we’ve discussed in these letters over the last two years has been quite effective at reducing risk during this difficult time.

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935 or send an e-mail to cameron.malott@engravewealth.com. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:
1. Smith Capital Investors, email to clients 3/15/20
2. Bespoke Investment Group, The Bespoke Report, 3/13/20
3. Bespoke Investment Group, The Bespoke Report, 3/13/20
4. Smith Capital Investors, email to clients 3/15/20

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