First Quarter 2020 Review

April 22, 2020

Sorry for the length of this quarterly letter – so much to address regarding the economic and financial fallout from the Covid-19 pandemic, the crash in energy prices and the imposed shut down of the global economy.

Counsel Trust managed portfolios contain high quality dividend and interest paying securities and funds that are temporarily lower, but will bounce back as the global economy is incrementally re-opened. It’s not often we experience such broad-based market decline as occurred in the first quarter. All asset classes except precious metals declined in panic selling reminiscent of ‘runs on the bank’ during the Great Depression.

Especially dismaying has been the extreme damage done to energy and natural resources – an asset class that we’ve been employing in portfolios to diversify away from equity volatility. Energy suffered a triple-blind side – first Covid-19, then an oil price war between Russia and Saudi Arabia and then, a closed economy – all three events, hopefully temporary.

Although it’s clear that the pandemic will eventually pass, quite a lot of damage has (and is) being done, the impact of which will last for a while. Unlike the dot.com crash of 2002 and the Great Recession of 2009, this pandemic / energy correction will heal more rapidly. However, here are some of the ‘longer leg’ aspects of this ‘black swan’ event:

The COVID-19 crisis is likely to shift the global economic ‘tectonic plates’

Increased nationalistic tendencies to look more inward; stronger borders
Less international free trade and business travel, especially with China
Less supply chain low wage manufacturing abroad
More national self-reliance – re-building domestic manufacturing capabilities
Greater production and labor costs, possibly resulting in higher product capabilities
Greater production and labor costs, possibly resulting in higher product prices
Heavier reliance on in the internet – more home shopping and entertainment
Increased security / password issues and hacking will require a major interest reboot made possible by 5G and blockchain tracking / accounting.

U.S. economic vitality and longest running bull market was suddenly cut short by pandemic fears and the government sheltering edict

Most rapid market plunge in history, (at least temporarily) bottoming out 3/23/20
The panic was due more to forced selling to raise liquidity than to fears of a recession
However, expect at least a mild recession as earnings severely decline for a while
Profound negative impact on small business and the consumer driven economy
Expect a slow U shaped economic and market recovery, including volatile market up’s and down’s

Unprecedented monetary and fiscal stimulus, compounding the unending Federal Reserve quantitative easing since the Great Recession of 2009.

$2.2 trillion CARES Act- combination business loans and direct employee payments
$2.3 trillion Federal Reserve stimulus – broad based bond buying and credit extension
The largest broad-based relief package and monetary expansion in history:
Support for individuals, healthcare
Support for small business & large industries
Support for state & local governments
Extreme global central bank accommodative monetary policies, massively increasing government debt

Aggressive fiscal and monetary policy cannot levitate real economic growth

Real U.S. GDP growth will come in part from a restructuring of manufacturing, however it will take time

Potential danger of re-emergence of inflation and U.S. dollar de-valuation

More detail for insomniacs:

Earnings have always been the driver of growth and appreciation in the stock market. Prior to the virus calamity, 2020 forecasted earnings for the S&P 500 was about $176 per share. The market peak on February 19^th was 3,386 – a ‘forward’ PE (price to earnings ratio) of 19.24 – on the high side by historic standards, but no-where near the PE in 2008 before the Great Recession.

Pre-pandemic, the economy was in great shape. S&P 2021 earnings were estimated at $196 per share. Assuming a PE of 19, projections for the index climbing to 3,700 to 3,800 seemed like a reasonable target, an increase of about 11%. Then, as we know, the virus blind-sided the world economy threatening everyone’s way of life and health. The most severe aspects of this economic interruption may not stretch beyond this year but there are still so many unknowns, suggesting a longer, more drawn out U (vs. V) shaped recovery. No question, fear of a re-infection will be on everyone’s mind until therapeutic drugs or a vaccine is discovered. Even after that, people will be more cautious about congregating in the multitude of places and events to which we’re so accustomed. Personal and business travel will likely become far more subdued.

Financially, one of the longer term, potentially troublesome aspects of the pandemic is the massive $4.5 trillion wall of money being thrown at the problem, coupled with a zero-interest rate policy. More debt monetization is also being created by the Treasury now buying and otherwise guaranteeing various financial instruments such as money market funds, repo’s, corporate, municipal (and even junk) bonds. This stimulus effort is far greater than the 2009 $831 billion fiscal stimulus, coupled with the monetary quantitative easing (QE) that continued unabated until late 2018. At that point, the Fed tried to put on the brakes, shifting to quantitative tightening, the purpose of which was to reduce the excess money supply to avoid future inflation. But the stock market swooned having been so addicted to the flood of new money and easy credit, so the Fed immediately reinstated QE. This looks familiar to the market’s most recent bounce off the March lows following the latest stimulus facilities.

Milton Friedman, the well-known monetarist economist said that ‘inflation is always and everywhere a monetary phenomenon” meaning that printing money at a rate faster than overall GDP growth eventually results in inflationary price increases. But we’ve had very modest consumer price inflation over the last 10 years – largely attributable to technology, outsourcing supply chain production and greater energy supplies. Thus, since 2009, it appears much of the new (fiat) money created from QE programs flowed into financial markets, further (speculatively) leveraged by the zero-interest rate policy. In other words, a strong incentive was created to borrow at very low, artificial rates to buy stocks and bonds on margin – now imbedded in the economy.

There have always been booms and busts in the economy (occurring about every 10 to 15 years from the late 18^th Century until 1907 when the Federal Reserve was created. These were normal business cycles or rhythms in a supply / demand – free market where speculative periods were corrected naturally in the process of true noninflationary ‘price discovery’. The Fed was created to smooth out the booms and busts, but good intentions have gone badly awry. The Fed’s monetary fidgeting have made the business cycles bigger and more volatile by smothering the normal price discovery system of the free market.

Much of the money printing from QE found its way into the financial markets. This time where will the new fiat money go? To the extent much of it is doled out in loans, later repaid by the beneficiaries and strong GDP growth returns, possibly inflation can be avoided. Following the economic recovery, it is important that the government deficit and debt are reduced. There is an opportunity for that to succeed assuming the U.S. dollar continues to be the world’s reserve currency. Otherwise, inflation can re-emerge. It is thus wise to maintain exposure to inflation resilient equities, bonds and real assets – natural resources, real estate, land, energy, metals and infrastructure.

Edward S. Crooks

Our Insights

First Quarter 2020 Review

Read More