By: Stash Graham
If the second month of the new decade gave us something to talk about, the third month provided us events that will be talked about for a very long time. At one point the Dow Jones Industrial Average (DJIA) and the S&P 500 were off from their index highs by -38% and -35% respectively. It was a sell-off that hit all asset classes with a record amount of selling pressure. Towards the end of the month, the market did rebound; however, as we explained in our “COVID Market Update 7” email, we are concerned that this near-term rally was going to be short-lived. The virus is going to be a passing depressant on our economy and buying opportunities will soon present themselves. Until these opportunities occur, we believe exercising extra caution as guardians of your capital is smart. March 2020 was the worst month for the US stock market since 1938, even with one historically good week, so we will continue to exercise caution.
Jobless claims paint a highly questionable forecast. The initial jobless claims grew to 3.28 million Americans for the 3rd week in March. This is worse than even the most pessimistic of estimates; Goldman Sachs had estimated 2 million Americans would file jobless claims. All estimates undervalued the impact of the virus on the business community. That trend appears to be continuing. Investment bank Barclays reported that 311 calls asking about Unemployment Insurance doubled in New York City over the last few days. Leaders in Washington, DC produced a $2 Trillion stimulus package to help the public and private industry cope with immediate fallout from the virus. The loss of income through layoffs is hard and inefficient to recapture. It will take years for employment stabilize and approach full employment (around 4% unemployment). Some institutional investors think that the historically bad initial jobless claims report will produce even more stimulus by the federal government in the future. This thought, and a couple developments, produced a quick rally in domestic markets as the 3rd week in March produced the best week since 2008.
Looking into the future, we believe that interest rates will continue to remain low. If the Federal Reserve wants to allow for an economic recovery, they are going to have to “grease the wheels” with low-interest rates. As such, focusing on sectors that perform well in a low-interest-rate environment should be our primary focus. First, all of the sectors that we will consider in the future will have companies with projectable revenue streams even if their underlying stock prices haven’t been performing well. We will also focus on companies whose historical stock performance is less dependent on stock buybacks. The 3rd virus stimulus package eliminates a company’s ability to buy back stock if a company participates in loans available under the package. We anticipate a lot of publicly traded businesses participating in the stimulus. This will remove a traditional tailwind for some business management teams. Secondarily, but related, businesses during times of economic contraction turn their focus to the debt side of the capital structure. Companies will look to move additional cash that was once destined for the equity (stock) side of the ledger and focus on paying down debt. Lastly, we anticipate looking at these sectors, which tend to be less cyclical and less volatile (an exception being sell-off like just witnessed):
Regulated Utilities– Utilities are companies that create and/or provide basic essential services. Businesses in this sector generally have very projectable cash flows as their returns on equity are determined by the state that the company operates in. The returns are moderate but consistent. Competition is limited. Regulated utilities are part of one of the more defensive equity sectors that we can participate when the market upswing occurs. In a low interest rate environment, utility companies can perform well.
High Grade Debt (US Treasury and Short Dated A- rated or higher Corporate Bonds)– The Fed/Treasury created a way for companies via a Primary Market Corporate Credit Facility to extinguish short term bank loans and swap into longer-dated low-cost bridge loans. Investment grade (BBB-rated or better) companies can borrow at an amount equal to 110% of their maximum debt outstanding over the last 1-year period. Higher rated credits can borrow more. The dollar amount of the program is large, showing the large commitment of the government to prevent specific businesses from coming under insolvency risk in the short term. As such, we feel very comfortable investing in investment-grade short-dated paper given the government’s willingness to backstop any troubled investment-grade companies. While the return is not that big (yields around 4% Yield to Maturity), the comparison of earned yield to a United States Treasury of the same length (0.2%) is advantageous for us.
Single-family and Multi-family home REITs- Home rentals, whether single-family homes or apartments, have been in consistent demand throughout the last 3 economic cycles. The demand for rentals has accelerated this past cycle. The issue has always been valuation. This virus will suppress earning power for a significant portion of their tenants; however, the stimulus packages will help. We consider renting the highest priority payment a household can have. As such, we believe landlords will be one of the primary beneficiaries of the stimulus packages. We are monitoring both debt and equity investment opportunities. A couple of the companies that we are monitoring right now trade about 40% below their 52-week high.
Investment Grade Telecom Companies- We emphasize “investment grade” because telecommunication is capital intensive. These businesses invest a lot of money every year in capital expenditures so during times of economic stress a company’s ability to access capital is very important. We believe a separation among the well-capitalized names and poorly capitalized names will occur. The businesses at the top of the industry have large moats protecting them from new entrants taking material market share. Finally, these businesses also pay consistently high dividend yields, which during a period of low-interest rates, are very attractive.
As mentioned in last month’s letter, communication during these stressful times is paramount. During March, the firm has sent out 5 email updates about the markets and economy. The email database we have is based on the information that Fidelity provided us and information provided by some clients. Please send us your information if you have an interest in receiving our market updates. As the markets continue to act historically volatile, we will continue updating you on our findings. Thank you for your continued trust in us during these hectic times in financial markets.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Graham Capital Wealth Management, LLC (“Graham”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Graham and its representatives are properly licensed or exempt from licensure.