3/20/2020 – The Virus Continues

As rough of a roller coaster as the last month has been, this week was actually the worst one yet. This was the third week in the last four that the Dow has declined by more than 10%. The Dow is now more than 35% off the highs reached in early February. Our portfolios weathered this downturn a lot better than the Dow, but it’s still been a painful and challenging time. We are well positioned in that everyone has more than 20% cash in portfolios that can be used to buy stocks at some point in the future. I dabbled a little earlier this week, but plan to remain conservative in deploying capital going forward. There is still a great deal of uncertainty around this virus. It’s difficult to value a company on an earnings basis when no one knows what earnings will be this year and next. The measures we are taking are hurting the economy to save our healthcare system. It’s hard to know whether the medicine will be better/worse than the disease, but we are currently erring on the side of healthcare. While no one knows what the future holds, it feels like things will get worse before they get better. For the week, the Dow declined 17.3% while the S&P 500 decreased 15.0%.

We need massive government involvement to get through this situation. People are already being laid-off and furloughed without pay. The government announced programs yesterday that would allow people financially impacted by the virus to defer mortgage payments for up to 12 months. That is a critical relief for most people. Housing is one of most peoples’ biggest expenses. Something will need to be done on rent, but a ban on evictions seems likely as well. We are shutting down large sectors of the economy. The next step is getting money directly to people. I initially preferred a more targeted approach where the government would backstop payrolls for struggling businesses, but I now think sending every American a monthly check makes the most sense. Congress needs to pass this quickly. People will start missing paychecks next week or the week after. Proposed numbers change from day to day, but if every adult received $1,000-1,200 per month and children received $500/month, people could continue to buy food and pay electric bills over this period. I would hope that people who keep their jobs and don’t ‘need’ the money would donate to friends/family in more need than the the main check can cover. We are truly in uncharted territory and need to keep the basic functions of society working – housing and food being the most important. I would love to see Congress pass this as a single-issue bill. We need money flowing to people as soon as possible as job losses start accelerating.

Bailouts of specific industries is a much more complicated process. We can’t allow this issue to delay getting money in peoples’ hands though. The 2008 bailouts were very difficult politically, although I believe necessary, especially in the financial sector. For whatever reason, over the prior 10 years, we haven’t put plans together for how future bailouts would work. Travel companies find themselves in financial distress after spending billions and billions on stock buybacks over the last 5-10 years. American Airlines spent $12 billion on buybacks since 2014 and now needs a bailout. $12 billion would pay 2 years of labor costs if the airline still had the cash. Boeing spent almost $40 billion in the same period buying back its own stock and is asking the government for $60 billion in bailout funds. In my opinion, there has to be some significant financial penalty for CEOs and senior management that made the decisions that left companies without the financial strength to weather a shock.

Some people would like to see the government let these companies go bankrupt and then reorganize with new equity holders on the back end. From a pure free market perspective, that is the best approach. Owners who made/supported bad decisions would lose money, but the businesses would continue to exist because long-term demand is there for the products/services. One major problem with this approach is the number of companies this could impact and the ownership of these companies by pension funds. Pensions, especially government pensions, are already in bad financial shape. This 35% drop in the the stock market has only exacerbated that problem. If many of these equity investments go to zero, it could create near-term problems for pensions to make monthly payments over the next few years. So the bailout likely needs to save current shareholders. This might end up being a situation like TARP where no one liked it or wanted it and it set bad precedents, but was ultimately the best option out of a list of poor choices.

Oil sold-off sharply again this week, decreasing an eye-popping 40.1% to close at $19.84/barrel. We haven’t seen oil this cheap since the late 90s. The yield on the 10-year Treasury decreased to close at 0.89%, from 1.01% last week. The average rate on a 30-yr fixed rate mortgage moved sharply higher to 3.65% from 3.36% a week ago.

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