Three Key Thoughts:

1. COVID-19 24/7

2. Deep Recession but How Long?

3. Stocks for the Long Run

COVID-19 24/7

From the earliest signs of the outbreak of a novel coronavirus in China in December to the full lockdown across Italy to hundreds of thousands of cases in the US, the last four months have been a blur. Seemingly in an instant, we went from prosperity to despair. What made this threat so devastating psychologically is that it was unpredictable, uncontrollable and of unknown duration.

As we deal with what we hope are peaks in infection rates and deaths, our daily lives are filled with news about COVID-19 and new routines spawned by the need for social distancing. We are just beginning to see the effects of a nearly complete stop imposed on major portions of our economy. Millions have lost their jobs and thousands of small businesses are failing. While we hope the good news about the near term course of the virus continues, we know that the devastating economic effects will be with us for a while.

The Federal Reserve acted very quickly in cutting interest rates and starting a number of programs intended to stabilize the financial system and credit markets. And, fortunately, the Federal government has stepped in with unprecedented relief. In a shockingly bipartisan effort, Congress enacted new programs to provide lifelines to millions of people in need and incentives to businesses to keep people on their payrolls. They are discussing plans for more stimulus, as it becomes clear that the scope of the damage to jobs and economic activity is astounding.

Deep Recession but How Long?

With major parts of the economy simply shuttered indefinitely, there is no question that we are now in a very deep recession. The unemployment rate will go from historic lows to Great Recession highs in a month. Businesses of all sizes will struggle to survive as their revenues have plummeted. The service industries – particularly those in travel, leisure and entertainment, which have become such an important driver of our economy -- will take a long time to re-open and return to some sense of normalcy. Many will take this opportunity to re-think their business models and adjust them to a different future.

On the positive side, many of us have discovered just how productive we can be WFH. It used to be that “working from home” was a pseudonym for mostly taking the day off. In the last month, it has become normal for so many of us – even TV news anchors and late night talk show hosts – and we have discovered that we really can get a lot of work done. We suspect these new experiences will accelerate changes that were in their infancy across a wide range of businesses and education providers.

We expect the technology and health care sectors to continue to lead the US economy forward, even as many other service industries struggle to right themselves. Just as BYOD (bring your own device) revolutionized business communications over the last decade, we believe WFH will drive a faster move to the cloud and a focus on the infrastructure needed to support a geographically dispersed workforce.

Right now, our health care system is in crisis mode, dealing with the critically ill while working furiously on treatments and vaccines. Once the immediate crisis has passed, we expect to see changes in methods and regulations that will allow our health care delivery system to become much more efficient and allow development of new tests and treatments in a more timely manner.

One of the great marvels of our economy is its ability to adapt to rapidly changing conditions. We will see that phenomenon play out over the coming months and years. In the short term, the pain will be great but we are optimistic that the future will be brighter.

Stocks for the Long Run

Market reactions to the shutdowns necessary to try to control the spread of COVID-19 were swift and fierce. From their record high on February 19th to their low on March 23rd, US stocks dropped 34%. The speed of this decline was without precedent. Investors in bonds had a similar reaction as anything but US Treasury bonds sold off harshly. Even high quality municipal bonds and short term investment grade bonds fared poorly as only the safety of US Treasuries would suffice. Ironically, long term US Treasury yields were also exceptionally volatile so investing in these was treacherous as well.

A combination of three important ingredients has buoyed the markets since March 23rd. First, the Federal Reserve’s various programs have calmed the fixed income markets significantly, allowing more normal market relationships to be re-established. Second, there is confidence that the Federal government will provide a great deal of relief to those individuals and businesses most hurt by this crisis. Finally, and perhaps most importantly, there is an emerging view that we are near or perhaps even past the peak in new COVID-19 infection rates.

We are confident that the Federal Reserve will continue to be effective within its limits. And, if bipartisanship can be sustained for a while longer, the Federal government does seem focused on many of the right priorities. We are less confident in the course of this virus and how changes in its course might affect our ability to re-open the economy. For right now, optimism has allowed stocks to regain more than half their losses. We will be surprised if this holds through the dire economic news we expect to see reported for the next several months.

That said, interest rates are once again at or near zero, providing no return to conservative savers. With values having declined substantially from their peak, we believe stocks will likely be the better place to be for those with a longer term investment horizon.

Investment Implications

The investment lesson of the 2008-2009 bear market was to stay invested, while harvesting tax losses to the maximum extent possible. This is a playbook we are following once again. In addition, we will carefully evaluate expanding exposure to “early cycle” investments like US small cap and lower quality credit, where the potential rewards may now outweigh the risks.