Two Sides of Every Coin

The financial markets are in a state of panic over the spread of the coronavirus outside of China and its impact on global growth. Stock markets are under tremendous pressure with extreme volatility as bond yields plummet to unheard of levels as investors seek safety at any price. Program trading is compounding the problem as selling occurs as rates fall and yield curves flatten/invert which are historic precursors for a recession.


While we clearly see a big slowdown in global growth in the first half of the year, we still see sequential improvement later on as China ramps up to over 90% of production by the summer reinstating all important supply lines and other economies follow suit, albeit slowly, if growth of the coronavirus gets contained during the second quarter which remains our base case.   Major advancements have already been made around testing and procedures to mitigate expansion of the virus. Governments, consumers and businesses are all reacting at breathtaking speed to protect people by containing the virus. There will be major winners and losers from all of this, so it is important to look at both. Even as the coronavirus gets controlled, we expect that there will be significant changes in mindset that will linger.


Monetary authorities are reacting to rapid decline in rates and flattening, even inverting, yield curves as investors seek safety in bonds at any price/yield. The Fed cut rates last week by a half point in an emergency move. This was an attempt to soothe the markets, provide added liquidity and steepen yield curves despite the fact that lower rates will have no real impact on the economy. We are dealing with a virus, not a financial crisis. We fully expect all monetary authorities around the world to lower rates as well as and inject added liquidity into the system. Lower rates are not the cure for a lower demand over fears of a spreading pandemic. It won’t help our economy nor demand if the Fed cuts rates another time later in the month as many assume. Same goes for the BOJ, ECB and all other monetary boards except maybe the Bank of China as the growth of the virus has hopefully peaked and business is slowly returning to normal. All markets looked right through the Fed rate cut last week understanding that it won’t do anything near term to boost growth. Our 10-year treasury yield ended the week at 0.76% with the 30-year treasury yield at 1.29%. Need we say more? Investors are willing to accept a significant negative real return for near term safety. Not us!


We would expect governments to introduce fiscal relief to boost demand.  That would be good. However, we do not believe that targeted bailouts will do anything for overall demand. It may only forestall major financial pressures in those industries most hurt by the spread of the coronavirus such as airlines, travel, hotels, cruise lines, entertainment, conference venues, casinos, restaurants, old line retailing, etc. We would not invest in these industries even at these stock prices until we can get a real handle around the financial impact of the precipitous drop in demand on their current and future results/balance sheets. The IMF pledged $50 billion to help countries hurt by the coronavirus. We need demand stimulus rather than lifelines.


While the pundits/experts are focused on the economic loss in demand from the growing fears of a pandemic, let’s look at the other side of the coin at the potential longer-term benefits. We mentioned some weeks ago that we expect consumers and businesses alike to refinance their mortgages/debt as rates declined at record levels. Well, it is happening. Corporations have sold over $215 billion worth of bonds since the beginning of the year, up nearly 7% from last year. Companies are reducing their interest costs by billions boosting profits and cash flow as well as lengthening their maturity dates.  Individuals are refinancing their homes at record levels. There are currently over 13 million homeowners who can refinance their homes today at these mortgage rate levels who could each save on average over $3500/year or $45 billion in total which could boost consumer spending in addition to what refinancing have already taken place.  Banks may benefit from growth in refinancing but lose much more from decline in spreads. We sold the banks a few weeks ago.


Texas crude prices plummeted to $41/barrel on Friday. That is down nearly $20/barrel in just a few months. Well, the U.S consumes over 140 billion gallons of gasoline and 68 billion gallons of distillate per year. The aggregate savings to consumers and businesses could exceed easily $60 billion if all passed along, which is not likely. Consumers will again have more money to spend and businesses will have lower operating costs down the road. However, the other side of this coin is that many energy companies will be in financial trouble due to the decline in prices which can be seen in widening debt spreads in the area. We would not want to own any banks in the energy area nor energy MLPs.


The consumer will feel almost immediately lower prices at the pump and but will not benefit from lower interest costs until refinancing their mortgages or other related debt. Lower utility bills are likely to follow too.  On the other hand, businesses are likely to rush into the debt market refinancing their debt/lowering interest costs and will benefit from lower energy prices almost immediately too. All of this are long term positives that investors must consider. Benefits from lower interest and energy costs will ultimately benefit world demand but with less impact than here as we are far more a consumer dominated economy than all others.


Many industries are benefitting as people spend more time at home for one reason or another using the internet for nearly every function: shopping, business, video conferencing, education, communication, entertainment, healthcare, and much more. So, who wins? All companies that provide these services directly and/or indirectly over the internet. We do not expect this shift to be a short-term phenomenon. Once you get addicted to shopping on Amazon, for example, they have you!


Unfortunately, stock markets fall indiscriminately taking no prisoners when program trading kicks in as fundamentals don’t really matter-at least for the short term. We must always remember to pause to review the facts and consider mindset shifts; consider asset mix with risk controls; do hard fundamental research and finally, invest accordingly.


We know that the coronavirus continues to spread worldwide. The total number of cases exceeds 101,000 worldwide with 377 in the U.S. and the total number of deaths total approximately 3500 with 17 in the U.S. Governments, individuals and corporations are moving rapidly to prepare for and contain the virus. Test kits are finally be sent out with labs ready to go. In addition, it appears that major progress is being made on meds to contain the virus and vaccines to protect against it. While no one knows when growth in the number of cases will peak, we are more confident than ever that this will be a one-off horrible event that will impact 2020 but not 2021 and beyond. We do not believe that the long-term growth fundamentals for China, the U.S, Italy and all others will be impacted by the coronavirus. If anything, this may be another excuse for bringing production back to North America from China and other countries.


We have lowered our forecast for global economic growth, including the U.S., for 2020 once again, as we do not expect to see a peak in number of cases until later in the second quarter. Clearly corporate profit estimates will come down too but the key for us is whether global growth and corporate profits will be back on track by the fourth quarter 2020. While we think so, it won’t be clear until we get a better handle on when the pandemic peaks. Watch interest rates. Higher rates are good as it means panic is subsiding.


We are factoring into our estimates that Boeing 737 Max comes back into production by the summer that will be a big boost to growth. Finally, we were pleased to see Biden do so well last week such that all the moderate Democrats have circled their wagons of influence around him against Bernie. We still think that Trump will win the election but would not be worried if Biden did.


The market hates uncertainty. It has not helped that all of the monetary authorities are ringing the alarm bells. Monetary policy is totally ineffective combatting a pandemic. We are watching to see if governments introduce fiscal measures to offset the demand hit from the virus. While low interest rates are normally a positive for the markets, it has not been the case here as it has been all about a flight to safety. While we cannot predict the daily moves in the market, we are very confident that prices will be much higher a year from now.


We continued to move defensive in our portfolios holding cash around 15+% or so. We sold all of our financials well over a week ago anticipating narrowing spreads, reduced our global industrial and commodity companies, added to technology (we suggest listening to the AMD investor day presentation); added healthcare; and pared back slightly on special situations.


Our weekly investment webinar will be held on March 9th at 8:30 am. You can join by typing into your browser. Feel free so send any questions in advance to us at


Remember to review all the facts and consider mindset shifts; turn off cable and look at your asset mix with risk controls; do independent research and …


Invest Accordingly!


Bill Ehrman

Paix et Prospérité LLC

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