Every once in a while, usually accidentally, Donald Trump makes perfect sense.
Trump so regularly says and does things that are callous and self-serving that it’s easy to reflexively dismiss him, but when he tweeted in reference to the coronavirus crisis that “we cannot let the cure be worse than the problem itself”, I was, after some consideration, in full agreement.
Oddly, his tweet reminded me of Brad Pitt’s casino speech from The Big Short. Pitt, who plays a character loosely based on a former Wall Street trader who bet big against the US housing market during the financial crisis, reprimands two of his young protégés who are enthusiastically cheering for the downfall of the US economy. Says Pitt’s character: “If we’re right, people lose jobs, people lose homes, people lose retirement savings, people lose pensions…. Here’s a number: for every 1% that unemployment goes up, 40,000 people die.”
Now, I don’t actually know if those numbers are accurate, but they certainly sound reasonable in light of the poverty, despair, homelessness and loss of health care insurance that accompanies every severe economic downturn. However, the point is this: economic hardship costs lives also.
Has the US reopened its economy in a prudent and systematic manner? Of course not. Has the President contributed to the US’s divisiveness and the spike in new cases? Of course he has. But at the same time, can the US economy remain in lock-down indefinitely? Absolutely not.
As we become fixated on the rise in new cases and the number of deaths, consider the troubling numbers on the other side of the ledger. Bankruptcies are skyrocketing, and will soon rival—and likely surpass—the levels seen during the 2008–09 financial crisis. The list of prominent corporations that have filed for Chapter 11 protection grows every week. Thus far, it’s become a who’s who of the oil & gas and consumer discretionary sectors (recently Chesapeake Energy and Neiman Marcus, for example), but these sectors are likely just the canaries in the coal mine.
Bankruptcies will inevitably spread widely across all industries.
And while we cheer the rise of technology stocks and the nearly full recovery of the S&P 500 in recent months, consider the flip side: the still-massive decline of the S&P 500 Banking Index. And this is no minor index. It contains all of the largest financial institutions in the US—JP Morgan, Wells Fargo, Bank of America, US Bancorp and Citigroup to name but a few.
We also know that these banks didn’t fare particularly well in the US Federal Reserve’s recent stress tests, which resulted in the Fed suspending dividends and share buybacks for the entire group. The stress tests were followed immediately by a Wells Fargo dividend cut with almost certainly more to come (the options market suggests that the top seven banks will cut their dividends by at least 30% in the coming year).
And the failure of the US banking sector to participate in any meaningful way in the overall recovery of the US equity market should be concerning to all of us. If you need the perfect example of a ‘red flag’, this might be it:
Y-t-d performance disparity between the S&P 500 Banking Index (white line) and the Nasdaq (yellow) and S&P 500 (orange)
A recent article in The Atlantic nicely summarizes the dangers faced by the US banking sector as well as the dangers of focusing solely on our health at the expense of the economy:
…health risks and economic risks must be considered together. In calculating the risks of reopening the economy, we must understand the true costs of remaining closed. At some point, they will become more than the country can bear.
The financial sector isn’t like other sectors. If it fails, fundamental aspects of modern life could fail with it. We could lose the ability to get loans to buy a house or car, or to pay for college. Without reliable credit, many Americans might struggle to pay for their daily needs. This is why, in 2008, then–Treasury Secretary Henry Paulson went so far as to get down on one knee to beg Nancy Pelosi for her help sparing the system. He understood the alternative.
So, as much as some might worship Dr. Fauci or brand those who reopen their businesses (or solicit these businesses) as fools, locking ourselves in our basements for the next year is also not a solution. A middle ground is required.
I believe that the US will eventually achieve a successful balance of a reopened economy and a controlled infection rate—it is, after all, the wealthiest and most powerful nation in the world. But achieving this balance is by no means a certainty.
The global economy is also fragile and probably can’t handle another major crisis. What a second crisis might look like is, of course, unknown. It could be something familiar and foreseeable, such as a further escalation of the US’s trade war with China or a second wave of coronavirus. But it might also come from out of left field. Deutsche Bank, incredibly, has actually cited volcanic eruptions and solar flares as cause for concern. (True story. You can read about it here.)
But, again, the point is this: there are ample and unforeseeable risks facing the US and world economies at the moment. And risks, by the way, are almost always unforeseeable. Was a crippling global pandemic on your radar back in January? While we can’t know the extent of America’s insistence on civil liberties over basic common sense, predict future trade relations with China or anticipate acts of God, what we can do is control our own portfolios.
What this means is having a mix of many asset classes, across many geographies and across many sectors. Balance and diversification. Defense and offense. Safety and growth.
If the world works out as we hope, you’ll still benefit greatly by owning a balanced portfolio. However, if solar flares shoot from Trump’s eyes and volcanos erupt behind him melting people’s faces like Major Toht from Raiders of the Lost Ark and cause markets to take another nosedive, your portfolio will still be ready and your downside significantly minimized.
And don’t laugh. Anything’s possible this year.
Easing the pain: hypothetical balanced portfolio (green line) vs Cdn equity market (blue line) during past bear markets
Click to enlarge. Source: Ontario Securities Commission. Sample balanced portfolio (50% Cdn equities, 18% US equities and 16% international equities) vs 100% Cdn equities. Total return.
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.
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