Eagle, CO

Coronavirus/COVID-19
Performance
Crypto
Jobs

Sequence of returns
Bear market rally
$6 Trillion (seconds)
“V-shaped” recovery

Where to begin?

So much has changed since my last post/letter. On March 5th there were 172 confirmed cases of COVID-19 in the USA, and I was preparing to head to Sedona, AZ for a short and long overdue vacation with my family. We left on March 11th and things were mostly normal so far as I could tell. But after only 1 day away my wife turns to me and says, “I think we should go to the grocery and stock up because there is evidently not much food and supplies left at the stores at home.”

At the supermarket in Arizona, things still seemed mostly normal but there was no hand sanitizer available at any price, and I was unable to use my own Yeti® cup for coffee at Starbucks – for the safety of the employees it was disposable paper cups only. One day we went to breakfast and the room was filled with maybe 40 people – all of them vacationers with suspicion in their eyes. Each day, there were fewer vacationers in each restaurant or shop.

I am writing this in a new world - one that didn’t exist just a month ago. And I seriously doubt that simple trips to the grocery, or more involved trips like to countries on the other side of the planet – will ever be the same again, after this.

As of this writing, according to data from Johns Hopkins University, there are 312,249 confirmed cases of COVID-19 in the USA, and more than 8,400 Americans have died with the virus. Almost regardless of how you do the math or count the cases – the spread is EXPLOSIVE.

Again, full disclosure, while I am well-studied and qualified to comment on statistics, portfolio management and human behavior related to finance – I am not a doctor, epidemiologist, or virologist and I do not give medical advice.

No matter how you count the cases at the beginning or today let’s just assume that 172 and 312,249 are relatively accurate, or at least scalable. The rate of growth in confirmed infections would be 181,440% in 1 month. These kinds of numbers sell lots of newspapers and many people (whether right or wrong) now fear going outside their homes. They fear interacting on any level with loved ones, let alone strangers. Even those who are not afraid of personally becoming infected and showing symptoms are afraid of carrying the virus and then passing it on to their elders.

This is a “Crisis of Confidence” type situation. And the markets, I fear, have only begun to reflect the reality.

Most folks believe that the stock market and the economy will recover because of course, it always has recovered. It’s generally just a matter of how long it takes, and which “shape” the recovery makes on a chart. There does of course exist the possibility that we do not recover this time, and the world as we know it ends. In which case, losing dollars won’t matter because dollars won’t be worth anything.

Odds are, the world does not end. Odds are, life goes on.

I think it is safe to say that the world will be different. All the subtle ways in which it will be different, we cannot yet know. But just as the airport was different after nearly 3,000 people died on September 11th, 2001, some things will change as a result of this pandemic.

I think it is also safe to say that the chances of a “V-shaped” recovery are statistically zero and becoming even less likely with each passing day that people are too afraid to leave their homes. The FED could print $1 million dollars and deposit it into a bank account for every American and it won’t matter one bit if people can’t (or are too afraid to) leave their homes and spend it on dinner, bowling, lift tickets, basketball games, and all the rest.

And the FED is printing money all right. More than ever before. By a LOT. Overall, the stimulus (so far) is at $6 Trillion. This number is impossible to grasp. For perspective on how much money this is…

1 million seconds………………………………………. is 11 days

1 billion seconds……………………………………….. is 33 years!

1 trillion seconds……………………………………….. is 31,709 years!

6 trillion seconds……………………………………….. is 190,258 years!

Our grandkids’ grandkids’ grandkids’…. (you get the idea) can pay the tab, I guess…

What we need are assurances (and evidence) that a Coronavirus diagnosis is not a death sentence. Then, we will need reminders. The assurances will come in the form of vaccines, proven treatments and enough ventilators for everyone. For whatever reason the number of recovered vs. dying doesn’t seem to be enough. The reminders will come from sources outside the normal news media in the form of statistical comparisons to death rates from everyday activities like driving a car.

In the meantime, the headline numbers will likely continue to get worse before they get better. The market will (over)react to most of the news – both the numbers and the additional economic stimulus that is sure to follow.

For the year 2020, the S&P 500 (SPX) has now lost value in each of the first 3 months. The index was down 0.16% in January, it lost 8.41% in February and then dropped 12.51% in March. For the year the index is down an even 20.00% through March 31st. From the intra-day peak of 3,393.52 on February 19th the SPX fell 1,201.66 points to the low of 2,191.86 on March 23 – a drop of 35.41% - before recovering some of its losses.

An important point: If something drops 35.41% in value, it would need to increase by 54.82% just to get back to even. Think about it this way – if you have $100 and you lose $35.41 you are left with $64.59. You need to make $35.41 to get back to $100. $35.41 is 54.82% of $64.59.

Our strategies have held up very well in comparison. We have lost less than the market in each strategy and therefore have a lot less to recover just to get back to even. For example, for the year the Income Strategy is down only half as much as the SPX at -9.19%*. To get back to even for the year, we only need to generate a return of 10.12%. The Appreciation Strategy is down around 15.06%* which means we need only 17.77% to get back to where we were at the beginning of 2020.

These are more manageable losses to recover from.

On top of the downside outperformance, we have an average of 42% cash across the strategies as of the end of March. This means we have the ability to buy great stocks at bargain prices. Perhaps what is more important is that we can reposition our strategies for the world that we will live in, post-COVID.

Speaking of downside outperformance, I feel obligated to note that it is actually really easy to outperform the market on the downside. All you must do is follow your stop-loss orders and hold some cash.

That’s it. No secret. There is basically no excuse for a professional portfolio manager not being able to do this.

Many advisors don’t do this though. Mostly because their compliance officers don’t allow them to get paid to hold cash, and partly because they have no plan for getting the money that goes into cash reinvested into productive assets when the crisis passes. They will hold the same investments on the other side of this crisis as they held going into it and instead of managing their clients’ money, these advisors will manage the clients’ behavior and expectations. The model for these types of firms (which is most of them) is to meet with people, gather assets, and “manage the managers” in a pie chart of funds.

These advisors are resigned to believing that “you can’t time the market.”

Well, I would submit that you can’t necessarily “time your retirement” either. And once you start taking distributions, you are an active investor whether you like it or not because the alternative is financial suicide. The goal must be to create cash when valuations are at extreme highs – not blindly withdrawal the same amount every year.

Let me explain.

Imagine if you had retired in December of 2019 with $1M in your portfolio. Your advisor told you that you could take about $50,000/yr (increasing at 3%/yr for inflation) and have a good chance of living happily ever after. Well – here are 2 scenarios (left and right) where the only difference is the order in which the returns happen. Both scenarios average 5% return per year. It’s just that one (on the left) starts with gains, and the other starts with a drop.

The portfolio on the left has distributed $1.343M of income and is still worth $870K at the end of 20 years.
The portfolio on the right distributed only $960K (1.007M - 47.7K) before running out of money in 15 years.
And the only difference was the sequence in which the returns happened from one year to the next.

You see, many advisors meet with prospects and clients all day which means they can’t be managing portfolios of investments all day. There is only “so much” time as we all know. Elevate is different.

Anyway, we will measure the success of our strategy using the whole cycle worth of performance – that means from market top (2/19/20) to the next market top. The other side of “beating the market” is getting the money reinvested into productive assets when the crisis has passed. We aren’t there yet.

And here is something interesting. In a world of no commissions, and no dividends (everyone is cutting their dividend), if you sell a stock at $50 that is on its way to $35 and then buy it back at $50 when it is on its way to $100 – you didn’t really miss out on anything but heartache. So, we prefer to hold cash and skip the angst, if at all possible.

We think we can do better, though. And we think the world is going to be at least a little bit different and the stocks we held two months ago may not make as much sense as the stocks we want to own a couple months from now. And we have no idea what may happen in the interim. So, we hold a lot more cash than normal.

Speaking of currency, in March the cryptocurrency bitcoin dropped by more than 50% before rallying 66% from the lows. It has been extremely volatile but as of the end of March, bitcoin (-10% YTD) was still down less than the S&P 500.

Interestingly, in a world where people are restricted to their homes Bitcoin makes even more sense than it used to. Nobody has to go to the office to process bitcoin transactions. Substantially fewer people are required to maintain mining computers that do the work. If banks were forced to close and bitcoin transactions continued to operate as usual it would be great support for the growth of crypto.

The fact that I even mention this possibility should tell you something about the current situation. It is the worst thing anyone has ever seen from an economic perspective. Never before in history have 10 million people filed for unemployment in two weeks’ time. And those people aren’t even reflected in the most recent monthly number which was the worst on record and increased overall unemployment by about 1%. Next month will probably be worse. I don’t know if this stat still holds up but according to Brad Pitt’s character in “The Big Short”, “for every 1% unemployment increases in the USA, around 40,000 people die.” If Oxford Economics projection of 16% unemployed by May comes to pass, that would translate to around 500,000 people dead (based on Brad Pitt’s numbers) from economic impacts alone.

While we will have to wait and see how the virus progresses before we have enough data to determine its mortality rate, and we already know the mortality rates related to unemployment (see Brad Pitt’s stat above), I am personally more worried about the loss of life due to the long and short term economic impacts of the global economy being shut down than I am about the virus. If the death rates for COVID-19 turn out to be much larger than currently projected, then I will change my mind.

Source: Wall Street Journal April 3, 2020

Even if the government and the news all came out today and said that we have the cure for COVID, there are plenty of people that aren’t going to leave their homes, and even more that aren’t going to spend what they would have otherwise. Vacations have been cancelled and with that the lost revenue won’t be “made up” with higher demand after this crisis. The demand will be lower, not higher. Which means the valuation multiples we saw before COVID-19 aren’t coming back any time soon.

Sure, the stimulus will help. But it won’t help everyone, and it won’t promote growth. It will barely be the equivalent of saving the patient from dying on the operating room table by inducing a coma. The patient (i.e., the global economy) will stay in a coma for an indefinite period until a cure is found.

The cure is the confidence to go outside again. The confidence to have dinner or be entertained with folks you love, while in close proximity to strangers. Only then will the global economy wake up from its coma and begin to function normally again. And then from there, perhaps we can get aggressive about buying again. Quoting Jimmy Carter’s “Crisis of Confidence”, one more time:

“The strength we need will not come from the White House, but from every house in America.”

Until the economy reopens, I am extremely cautious about markets. We have bought a few stocks and bonds recently at what I thought represented very good long-term value, but as I mentioned before we still hold plenty of cash.

I have no idea how long this situation will persist (nor does anyone else), or how bad it may get before we find a bottom (perhaps we already have) but our rules-based strategy is designed to protect your capital when markets are going down – no matter the reason – and participate in the upside when the markets are trending higher. While this time is certainly unique – it is not completely different, just humans behaving irrationally like always.

Now is not the time to “ride it out” and anyone who tells you it is “a buying opportunity”, isn’t paying attention and is probably wrong. The truth is that nobody knows what tomorrow holds. The situation could get a lot worse before it gets any better and it is always possible that we could have seen the bottom in stock prices, already (I seriously doubt it). The only thing I know for sure is that nobody knows for sure – not the doctors, not the hedge fund managers, not “the banksters” and not me.

I suspect that in a nation of retail salespeople, counter workers and cashiers, where only 40% graduate from college and according to the Federal Reserve, “many adults are financially vulnerable and would have difficulty handling an emergency expense as small as $400”, it will take a lot longer to recover from unemployment of historic proportions than many in the financial media are predicting.

That doesn’t mean we won’t find opportunities to invest along the way. But be prepared for a longer recovery than what we saw in the markets after December 2018. If I am wrong, which I would love to be in this case, our buy signals will get us back into our best ideas very quickly.

Make no mistake, we are in a bear market. And some of the biggest stock market rallies happen during bear markets. These “bear market rallies” as they are called, spike quickly before fizzling out and ultimately trending even lower. Here is a look at some bear market rallies during the financial crisis:

This post is not meant to be depressing or anything. Just a healthy dose of reality. The situation is bad and getting worse. Each day people don’t get back out and do things they would normally do - adds maybe a week to the recovery. If these facts change, I will change my mind. But for now, I do not see this as a time to get aggressive.

Elevate is open for business. We are working from home but taking our responsibility to you very seriously. If you have worries about your portfolio, or if you are losing any sleep about your finances – please give us a call so we can help you get repositioned into an allocation that suits your current feelings about risk and reward.

As always, thank you very much for reading!

Until next time,

Shane Fleury, CFA

Chief Investment Officer

Elevate Capital Advisors

*This is YTD. From the high, Income Strategy is down 16.81% and needs to generate 20.20% to get back to the all-time high. The Appreciation Strategy is down 25.62% from its high and needs to generate

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