The Year of the Virus
The economic focus in early January was on the trade deal between the US and China and what the next step in US-Global trade policy might look like. Most economists were forecasting steady but slowing global economic growth as the Federal Reserve had just lowered rates in what was referred to as a “mid-cycle adjustment”.
It is clear now that the record eleven-year economic expansion that began in the aftermath of the Great Financial Crisis (GFC) is now over. Economists are now expecting economic data that we have not seen since the depression era.
In the past month, over twenty million Americans have filed for unemployment benefits and expectations are that more claims are likely to follow. The unofficial unemployment rate is already estimated in the mid-to-high teens from recent historic lows.
In the weeks and months to come, it will be vital to keep in mind that this economic contraction was voluntarily made and is an investment in public health. Social distancing and self-quarantine measures are mitigation efforts to slow the spread of a highly contagious disease that escalated into a global pandemic. So far, it is working.
The good news is the economy was in good shape prior to March of this year and our government’s response to the pandemic has been swift and historic in its size and scale. Our government learned, from the GFC, that it needs to maintain liquidity throughout the economy. This will help prevent a credit crisis on top of a health crisis.
The Federal Reserve has gone above and beyond the extraordinary measures it took in the aftermath of the GFC. There are no indications that this should change. Markets are functioning in an orderly fashion and the banking system is well capitalized.
The fiscal stimulus that was recently passed was ~10% of GDP and exceeded expectations on its support for American workers. Substantial support was given to small business owners and there are already talks of expanding these programs. Additional funds have been made available to industries that have been hit particularly hard and are considered vital to the recovery. The airline industry is a good example.
Our government knows it needs to provide a financial bridge for those in need until we can overcome this health crisis. The fiscal and monetary support enacted so far will help the eventual recovery once economic activity slowly begins to ramp back up.
The Healing Process
We need to overcome the medical crisis before we can begin rebuilding the economy. As shocking as the short-term economic data might be, we know that in time we have a high likelihood of developing therapies, a possible vaccine, and eventually herd immunity from this disease. In fact, all three of these things have been happening since the outbreak began. We are also buying time to shore-up our healthcare system so we may expand capacity and adequately protect our healthcare workers on the frontlines.
The history of pandemics is clear. There is a tendency for outbreaks to occur and disrupt human activity and lives and then eventually we recover. We also know that after unforeseen calamities people tend to “over-insure”.
Most economists expect both personal and corporate savings to increase after this event. There is also an expectation that resiliency in supply-chains will be increased. This could benefit American manufacturing in time. Investments in healthcare supplies and technology will likely be bolstered in both the public and private sectors. Technologies and work processes will likely adapt to allow for more work-from-home arrangements. In short, there will be a lasting impact in both consumer and corporate behavior.
In response, we have increased our use of active management investment strategies to help our portfolios adapt to this new environment. We were early adopters of the low-cost passive investment strategies and products that have overtaken our industry in recent years. We are always focused on ways to lower costs and increase efficiencies in our business.
However, in this environment there is real value in utilizing actively managed investments that can adapt to the rapidly changing landscape. We observed this in a number of our funds as they significantly out-performed their benchmark indices as the March sell-off unfolded.
During economic and market shocks it is essential to keep your guiding principles for investment in mind. At Cornerstone Advisory, we invest with a long-term perspective, maintain diversified investment models and rebalance on a regular basis. We also work closely with our clients to be sure that we have a clear understanding of their tolerance for risk and the context of their financial plan.
Studies consistently show that diversified portfolios deliver less volatile returns with faster recovery times. The below chart illustrates this point.
Source: JP Morgan, Barclays, Bloomberg, Federal Reserve, Robert Shiller, Strategas/Ibbotson
Any single year can present significant amounts of volatility for portfolios. The above chart illustrates that in time that volatility is reduced and tends to lead to positive returns for investors. We actively plan for challenging markets in our investment process.
If you have any questions or would like to have a conversation, please reach out to us or your portfolio manager.
The Cornerstone Team
Disclosure: Cornerstone Advisory, LLC, is registered as an investment adviser with the SEC. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. Registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment or strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals, and economic conditions may materially alter the performance of your portfolio.