March 18, 2020
By Mitchell Anthony
Unfortunately this virus and its ability to spread and penetrate the globe was misunderstood by us and by most investment managers worldwide. While the world watched selective footage of the virus grip China it was unclear what was being done in China to prevent and contain the spread of the virus and how America would have to react if the virus reached American shores. Historically coronaviruses that began in China never reached the rest of the globe in a significant manner. However this time the virus has spread quickly across the globe and threatens human life. As a result the globe has taken a very defensive posture against the virus.
Government and corporate leaders across the globe have had to weigh the impact of the virus on human life versus the impact of extreme defense measures on economic activity. Thus far economic survival has fallen and given way to maintaining human health around the globe. Historically capitalists have sacrificed sometimes almost everything including health for economic and financial gain and prosperity, however in today’s world capitalism has fallen in rank dramatically to our current society’s goals about life and health for humanity.
As a result all precautions possible at any expense are being taken to prevent the virus from taking any more lives than possible. Economic activity is being shut down either voluntarily or forcefully across the globe. Some industries will not survive if the shut down lasts longer than a few months or so. Unfortunately many businesses and industries within our economy are highly leveraged with debt and are not in a position to operate in shutdown mode for much longer than a few months without a lifeline or some way to prevent debt service from forcing bankruptcy.
Airlines and airline producers, oil and gas production and exploration, railroads, cruise lines, entertainment parks and theaters, are all highly leveraged with debt and have never been in a position of having to shut down their businesses and restart them months later. Most of these industries will need a lifeline from the government to survive if the shutdown lasts longer than two months.
We have taken significant defensive action for our asset allocation portfolios (dynamic growth and asset allocation income) where we are authorized to move to cash or to other asset classes when needed or appropriate. We have two versions of each of these strategies. One version is for qualified money and the other version is for nonqualified money or taxable portfolios. The actions we have taken have been entirely different in these portfolios as we are trying to minimize tax consequences for the nonqualified portfolios. In dynamic growth and asset allocation income we have moved to approximately a 50% cash position in both nonqualified and qualified strategies. We have eliminated all positions we think are at risk of survival if this quarantine lasts longer than several months. We have maintained the positions we think are highly leveraged to economic activity that is stable, and companies that have minimal exposure to debt. The best-performing stock in our portfolios has been the largest position in the portfolio (AMZN).
The defensive action we have taken has created significant alpha for our asset allocation portfolios in this declining market. Both dynamic growth and asset allocation income have over 1000 basis points of alpha in 2020. For example today the Dow Jones industrial average was down 6%, compared to a loss of 1 ½% for dynamic growth. (450 BPS of alpha) AMZN was up over 1% today!
We are not traders but investors and all of the capital we manage is long-term investment capital. The S&P 500 and Dow Jones industrial average have corrected over 30% thus far and may well correct 50% before this correction ends. Given our 50% cash position and superior holdings we suspect that a further decline by 20% in the Dow Jones industrial average would likely cause less than half of that decline in our asset allocation portfolios. However there are no guarantees and the leadership in the market could change dramatically at any time.
We have thought of moving to 100% cash position in our qualified portfolios. However the reason an investor would do this would be based upon a thesis that our economy is not going to get through this crisis in a reasonable period of time and that we will be in a depression or recession for many years. Historically America has bounced back quickly from crises of all types. This crisis while significant comes at a time when America has itself positioned the very best that it has been throughout history when it comes to the balance sheets of corporate America and consumers, and the liquidity of our banking system. Our Federal Reserve is willing to take whatever steps are necessary to provide liquidity to the system. Further Washington is ready and willing to provide lifelines and stimulus to restart our economy once we come out of the lockdown.
It would seem reasonable that we will have at least one quarter of negative growth and possibly two. I don’t see this virus lasting more than six months in a significant manner. It will either burn itself out or we will stop it with a vaccine that will become available by the end of the year. The economy will be down undoubtedly however the question that remains is whether it’s down for one economic quarter or four quarters. The service industry and retail industry will be the hardest hit. We have no holdings that we believe have much exposure to those industries. We are ready to take positions in healthcare, consumer staples, and gold with the cash we have raised as soon as we see some signposts that fear and panic selling are waning.
Americans are a very optimistic group and we believe we will get through this and as a result we remain optimistic about the returns that lie ahead for the financial markets and our managed portfolios.
While most of our clients are in one of our asset allocation portfolios, some of our clients are invested fully in equity only strategies (Diversified Equity and Equity Growth). We have not made significant change to these strategies or moved to a cash position as the goal with these equity only strategies is to remain fully invested in equities all the time and work to optimize the holdings in equities. These two equity only strategies are faring quite well through the downturn despite being fully invested. Amazon is the largest position in these portfolios and is unchanged for the year. If you are unsure what strategy you are in then please feel free to call myself, Dane May, Kyle Aron, or Ryan Greco at 852-4100 and we will address any concerns you may have.
We remain deeply concerned but optimistic.