Quarterly Commentary: Q1 2020


Life disrupted!

We hope this letter finds you well and in good spirits as we weather these unprecedented global events.

On December 31, 2019, the World Health Organization (WHO) first reported a mysterious pneumonia that was sickening the people of Wuhan, China. Little did we know this situation would morph into a global health crisis rivaling the Spanish Flu of 1918.  On February 2, 2020, travel restrictions from China to the U.S. were imposed, then expanded to include Europe and the U.K. By March 13th, President Trump had declared the outbreak a national emergency. One by one, virtually every state in the U.S. has declared some form of stay-at-home order that is still in effect.

The cascading pandemic and subsequent government induced economic coma has temporarily shuttered everything from dentists and doctors, to restaurants and bars, hairdressers, and a host of other businesses. This massive shutdown precipitated the fastest move to a bear market on record, with the S&P 500 dropping 34% in 22 days!

Most of us are trying to adjust to a new way of life in the midst of the pandemic while waiting for signs of the worst of this to be over. Tragically, some good people are dealing with loss of life, jobs, or businesses during this challenging period. The economy and markets are trying to find the appropriate levels that reflect this new normal.

As we embark upon the second quarter of 2020, the focus of this letter is to provide an update on where things stand as of this writing, review the actions the Fed and Treasury are taking, as well as offer insights and lessons about our current circumstances.

Current state of affairs

Using Italy as a benchmark, we ended the first quarter bracing for the worst from the spread of COVID-19 in the U.S. Some areas like New York City were showing grim statistics, while reports from other pockets around the country suggested there was more to come. “Flatten the Curve” became the battle cry as we sought to reduce the strain on our medical system, and ultimately to put us in a position where we could realistically consider coming back to work.

As it stands today, in the U.S., roughly 700,000 individuals have been infected with COVID-19, claiming 26,000 lives. Projections for the direction of the curve are beginning to give an indication that we are sufficiently changing the pandemic’s trajectory. This, combined with the ramp up of more efficient testing methods and a progressive understanding of the virus, has governors around the country considering limited reopening of their states beginning in May.

Economically, the U.S. has never experienced a wholesale shutdown of this magnitude. This makes economic and market visibility poor with wide ranges of outcomes projected by analysts and pundits for the short to intermediate term.

The general consensus is that the U.S. will have a recession, with steep declines in GDP for a quarter or two, and then gradual improvement in economic activity commensurate with our ability to keep the virus at bay while conducting business. Most agree that we will not get back to economic normalcy until we find effective treatment and ultimately a vaccine for COVID-19, and even then, it will likely be under a new normal.

Despite the economic shock resulting from COVID-19, markets have been rebounding in recent weeks, with noted exceptions, mostly due to announcements by the Fed and Treasury on ways they intend to bridge the gap in employment and business activity. News of notable progress in flattening of the curve has also boosted investor spirits that an end may be in sight.

Fiscal and monetary response

“I am from the government, and I am here to help.”  – Ronald Reagan

The Federal Reserve and the Treasury have been quick to respond to this economic shock, having learned valuable lessons from the Great Recession as to timing and magnitude of mitigating actions. To help you understand the magnitude of their response, we provide the following recap of the measures taken so far:

  • March 6: The President signs $8.3 billion emergency spending package to provide funding to manage the outbreak and for vaccine research. 
  • March 12: The Fed announced it would inject up to $1.5 trillion into the financial system in an effort to combat potential financial disruptions brought on by the coronavirus.
  • March 13: President Trump pledged that all interest on federal student loans would be waived for the duration of the coronavirus emergency.
  • March 13: Trump declares national emergency freeing up $50 billion in financial resources for economic assistance.
  • March 15: Fed cuts rates to zero, launches $700 billion quantitative easing program.
  • March 17: Fed takes new steps to keep money flowing, including a new Primary Dealer Credit Facility to support the flow of credit to individuals and businesses.
  • March 18: Trump signs coronavirus relief plan to expand paid leave in light of the virus.
  • March 20: Trump invokes the Defense Production Act to mobilize private business resources to fight coronavirus. 
  • March 23: Fed pledges to buy “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.”
  • March 28thPassage of the $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES Act) providing relief for individuals and small business.

Insights and observations from the front lines

It is no surprise that many of the relief programs for both individuals and businesses have challenges in their rollout. The sheer magnitude and logistics of such large endeavors was bound to cause confusion, inefficiencies, and bottlenecks.

Furloughed individuals are beginning to see their unemployment claims processed both on the state and federal level, as well as their one-time relief payment of either $1,200 or $2,400.  Millions are taking advantage of liberalized loans/distributions from retirement plans, the delayed tax filing deadline, suspension of student loan payments, as well as rent and mortgage forbearance. Yet, after a month or so without a regular paycheck, many Americans, already ill-prepared, are feeling the financial strain from the shutdown, which could get more troublesome the longer these circumstances last.

For the small business community, things have been even more challenging. The two main programs designed to assist them, the $349 billion Payroll Protection Program (PPP) and the Economic Injury Disaster Loan (EIDL), were launched with little initial guidance and have gone through a number of modifications in real time.

EIDL loans were touted as immediate relief, with $10k arriving in as little as three days and forgiven completely if the SBA denies them the loan. Demand for the EIDL was so overwhelming that the Treasury modified the program mid-stream lowering the forgiven payment to $1,000 per employee, and the three-day promise was abandoned.

For those seeking PPP loans, the challenge is that the program was designed to keep employees on the job, so the company remains intact throughout this disruption. The loan is a function of payroll costs, so businesses can only borrow based on this expense. Once a business receives the loan, the clock starts on an eight-week forgiveness period where the loan will become a grant if it is used it to pay employees (25% can be used for rent, utilities, etc.).

While this program will work well for some, many of our business owner clients have found themselves in a situation where their businesses are closed or bringing in limited revenue and many have been forced to furlough employees. The competition for a finite amount of loans caused them to scramble to apply. Now they receive the loan with no visibility of when they might be back in business, yet in order to be eligible for loan forgiveness, they need to keep or bring back staff in the hopes of timing the return of business perfectly. If not, they are saddled with a loan for staff they didn’t need. If they wait to apply, they may lose their staff permanently or risk the loan funds drying up when the timing is right to apply.

During the writing of this letter, it was announced the funds from this round have already been exhausted. Further, there are many businesses where payroll is not a majority of their total business expense, so the PPP loan amounts are inadequate and there is little relative forgiveness. Congress is working with Treasury for a potential $250 billion in addition funding for this program.

Keep in mind that 90% of businesses in the U.S. employ less than 20 people, and if you include sole proprietorships, the number rises to 98%! Neither one of these programs appear to be meeting the needs of a large percentage of these businesses. In the Great Recession, the SBA processed roughly $30 billion in loans. Due to the magnitude and swiftness of this disruption, the SBA is being asked to process over 10 times the amount of loans in less than 3 weeks. Plus, this is without consideration of the issues we raise above. Even in light of the depth and breadth of government assistance thus far, the SBA clearly has more work to do in meeting the needs of our small business community.

Market insights

Now that we are sheltering in place, it is easy to stay glued to our screens. As we watch headline financial news, we see the daily tally of the percentage gain or loss in a given market index: “The S&P plunged 8% on new coronavirus deaths” or “the Dow has rocketed 20% off recent lows.”  So, what do the market swings mean to your portfolio?

The mathematics of investment returns is often misunderstood causing investors confusion during periods of high volatility.  For example, the below chart of two-year returns demonstrates how return statistics can be misleading.

You’ll see, the mathematics of gains and losses are related but not equal. In times of high volatility, these dynamics are magnified and can create a sense of anxiety. A diversified portfolio of stocks and bonds can take advantage of these dynamics. The example below demonstrates how gains and losses are not equal. On the left, an investor loses 50% in year one followed by a 50% gain in year two. On the right, the investor gains 50% in year one and loses 50% in year two.

$100,000     Beginning balance                         $100,000     Beginning balance

-$50,000      -50% Year 1 return                        +$50,000     +50% Year 1 return

$50,000       End of Year 1 value                        $150,000     End of Year 1 value

+$25,000     +50% Year 2 return                       -$75,000      -50% Year 2 return

$75,000      End of Year 2 value                          $75,000       End of Year 2 value

As you can see, despite the fact that the investor had a gain of 50% and loss of 50% in two successive years, the total return was a loss of 25% and the order of the gain and loss has no impact.

When the market is experiencing high volatility, portfolios can move up and down dramatically. This is one of the fundamental reasons why a portfolio with both stocks and bonds can perform well relative to portfolios with all stocks because many times they exhibit substantially less volatility.  Stable assets in a portfolio dampen downside volatility while providing “dry powder” to buy stocks at lower levels in an attempt to capture the gains when markets recover from a substantial decline. For instance, the recovery from a 25% decline requires a 33% gain.

It is virtually impossible to predict the exact highs and lows on either side of market movements, but reducing loss and having accessible capital provides a way to take advantage of a pending recovery. This concept is not limited to the balance between stocks and bonds. It can also include a balance between large company and small company stocks, U.S. versus international, value versus growth, and other asset classes.

Unexpected events such as our current pandemic crisis, remind us of the importance of having a comprehensive financial plan in conjunction with a well-diversified portfolio and disciplined saving and cash flow management. Building detailed plans that consider potential contingencies is critical to making good decisions in times of personal, economic and market challenges. Having these matters in order remains the best path to a peaceful and rewarding future.

Communications to keep you informed

In an effort to efficiently provide you with timely communications, we have been sending occasional updates on important topics via email. Please visit the Insights tab for the full suite of communications. If you have not been receiving electronic communications from us, please contact our office so that we can confirm your preferred e-mail address and help you whitelist these communications so that they are not caught in your spam filter.

In the spirit of electronic delivery and access of important documents, we will be rolling out the option of electronic delivery of your quarterly reports to a secure online vault. The vault is where we are targeting for the next quarter electronic delivery of your statements. We will be reaching out to you to confirm your delivery and communication preferences.

Stay the course!

For informational purposes only. Not intended as investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of writing and are subject to change without notice. For more information about Wealth Dimensions, including our Form ADV Part 2A Brochure, please visit https://adviserinfo.sec.gov or contact us at 513-554-6000.

Please be advised that this material is not intended as legal or tax advice. Accordingly, any tax information provided in this material is not intended and cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

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