There’s an old joke in finance, that the stock market has predicted 10 of the last 3 recessions. It’s funny because it’s true; the stock market is notorious for over reactions.
Today, stock markets around the world fell as plunging oil prices and the Coronavirus amplified fears of a global recession.
Oil markets are undergoing a seismic shift, following OPEC and Russia’s failure to reach a supply deal Friday. In response to Russia’s refusal to cut supply, OPEC launched a price war sending crude oil prices down 22%. In reaction, stock prices of the major integrated oil producers fell a record 14% to 22%, intraday. Exploration and production companies fell even more, with Apache shares touching an intraday low of $9.32, off 54.97% from Friday’s close. It’s estimated that Royal Dutch Shell, Exxon, and British Petroleum need $50 per barrel oil to finance the capital expenditures and dividends in 2020. The equivalent break-even for Saudi oil giant Aramco is well under $20 per barrel. As global demand for oil falls, investors want higher dividends and stock buybacks, as opposed to more capital spending on oil projects. Lower oil prices will result in lower rates of inflation, a stronger US dollar, and lower earnings for energy producing companies.
As of today, the Center for Disease Control estimates there have been 32 million people in the US that have come down with influenza since this year’s flu season began in late September, resulting in about 18,000 deaths. In contrast, as of Thursday, health officials have confirmed 97,876 cases of coronavirus infection resulting in 3,347 deaths across the entire globe. In the US, the number of reported coronavirus infections is significantly smaller, with 177 reported cases and 11 deaths. That is a minute fraction of the US population, at nearly 330 million people.
Work on a vaccine is underway with human trials set to begin in a study being conducted by the National Institutes of Health. This vaccine was able to advance to human trials within 3 months because it was developed utilizing the virus’s genetic code. In all, 9 drug makers are moving forward with plans to develop a vaccine to target the Novel Coronavirus. At this time, it is estimated that a tested and FDA approved vaccine will be available within 18 months. Fears appear to be overblown.
The Fed cut interest rates 50 basis points last week in response to the Coronavirus. Chairman Powell acknowledged the economy’s strong fundamentals, but said “the coronavirus poses evolving risks to economic activity.” It is important to keep in mind that the US economy remains strong today. Last Friday, Nonfarm payrolls increased 273,000 in February, far surpassing forecasts of a 175,000 gain. Over the past three months employment gains have averaged 243,000. Strong employment gains like these have not historically preceded recessions.
Long term interest rates fell in response to forecasts of slower global growth. The yield on the 10-year Treasury note fell to a historic low of 0.40% today. Low interest rates are expected to bolster interest sensitive sectors of the economy, such as housing. Falling interest rates also make dividend paying stocks more attractive relative to bonds. Today, a record high of 70% of stocks in the S&P500 sport a dividend yield higher than the 10-year Treasury note yield.
2020 is a presidential election year; historically the 4th year of a presidential cycle has been volatile, but returns have been positive 78% of the time. Historically, once uncertainty subsides the uptrend in the stock market resumes.
Stock market valuations remain attractive. Today the S&P500 is trading at 17.8 times 2020 earnings, and 16.2 times 2021 earnings. Low interest rates and a strong US job market continue to boost earnings for US companies.
Haven’s Response and Strategy:
Our stock portfolios are diversified, exclude international markets, and energy exposure is very low. Further, we are overweight Large Cap and Growth oriented companies. While this positioning has not been immune to the current pullback, it has generated meaningful outperformance against the major market indices and minimized volatility.
Haven has been buying short maturity high yield bonds on behalf of moderate and conservative clients. Yields range from 4.1% to 8.9% with most maturities occurring before 2025. Further, Haven’s bond portfolio excludes energy exposure.
Haven’s preferred stock holdings have benefited from the Fed’s interest rate cuts, appreciating in value ~2%. Our preferred holdings generate an annual dividend yield ranging from 4.95% to 6.20%.
Many of the bond and preferred stock issues noted above are callable. If called, proceeds may be reinvested at lower interest rates.
We are optimistic that equity markets in the US are close to a bottom and believe that portfolios are currently well positioned. While no one can predict how long the current correction will last, fundamentals remain strong for US companies. There will definitely be supply chain disruptions but we believe the effect may be temporary (i.e. 1 to 2 quarters).
Please call with questions and concerns. We are happy to take your calls and discuss the specifics of your portfolio.
The Haven Wealth Group Team