Dear Clients and Friends,
I hope this letter finds you well during this difficult time. This Bragg update includes:
Bragg Financial is open. I am fortunate to report that all Bragg employees and their family members are healthy at this time. We hope that you and your loved ones are also healthy. Most of our team is working remotely due to the recommendations regarding social distancing. Our phones, computers, trading capabilities, mailing procedures, and account administration processes are in full working order. As part of our effort to keep everyone safe, we ask that you avoid coming by the office unless it is absolutely necessary. Please call or email us if you need us.
During this period, we plan to conduct client meetings remotely that replicate in-person meetings as closely as possible, utilizing phone, video, and other technology. If you have a meeting on the calendar with Bragg, we will contact you to prepare for this.
Our Clear the Clutter paper-shredding event which was scheduled for April 21 has been postponed. Please stay tuned.
All quarterly performance reports will be delivered electronically this quarter. Ordinarily, many members of the Bragg team work together over most of a week to generate and assemble quarter-end report packages. Electronic delivery will help to protect the health of Bragg employees during this time and will eliminate another piece of US mail that you receive. The reports are scheduled for delivery to your Bragg Client Portal on April 10th. If you do not use the Bragg Client Portal, your report will be sent to you by email. This is a great time to begin using the Bragg Client Portal if you are not doing so. Simply email Debbie Taylor if you would like to set this up. Paper reports will be available again once the virus has passed.
The US Treasury announced on March 20 that Tax Day was being moved from April 15 to July 15. Taxpayers and businesses will have that time to file and make payments without interest or penalties. Individuals can defer up to $1 million of tax liability and corporations can get an extension on up to $10 million.
Given the drastic shut-down of significant parts of the economy, the US very likely has entered a recession. Please click this link to read an article by Matt DeVries, CFA, one of our portfolio managers at Bragg. The article defines a recession and discusses the impact of recessions on the stock market.
As you know, the stock market (S&P 500) has fallen dramatically and painfully—about 29%—from the high of February 19th. Market swings have been exacerbated by computer-driven trading. Computer-driven trading is not new, but it is much more prevalent today, and it is contributing to the volatility we are seeing. Also contributing to the volatility and rapid descent are the trades of investors, whether individual or institutional, who employ leverage or debt as a part of their investment process. Many of these investors have received margin calls and are desperately seeking liquidity, selling anything they can to raise cash to avoid insolvency. We last saw this phenomenon after the collapse of Lehman Brothers in the fall of 2008. This selling has of course pushed stock prices down but it has also put downward price pressure on securities normally seen as a safe haven such as Treasury securities, highly rated corporate and municipal bonds and gold. The declines in these safer asset classes have been very modest—in the range of 1% to 5%.
But the primary contributor to the stock market decline is the fact that stocks aren’t worth what they were when this crisis started. Investors (“the market”) recognize that the economy is very likely entering a recession. The market recognizes that corporate earnings are going to be lower and prices are adjusting accordingly.
Watching the market plunge, one might conclude that the market is “broken,” that all investors are panicking and running for the exit, and that there will be no bottom. As a 12-year-old in my household asked me last night, “Can it go to zero, Daddy?” I answered my son’s question by saying, “It can go to zero but it is very, very unlikely that will happen and you should not worry about that.” But it could go to zero. The value of our shares in Walmart, JP Morgan, Amazon, McDonald’s, Google, Apple, Microsoft, and all of the other companies in which we are invested can go to zero. The value of a US Treasury bond can go to zero. The value of a North Carolina municipal bond can go to zero. But for this to happen, we would need something much worse than COVID-19.
This virus is bad and a lot of people will get sick. It is a sad and scary time. But based on the evidence before us, it is highly likely that this virus will pass and that people, the economy, and these companies will get back on their feet, move forward and prosper again. So while it looks like the market is out of control, it isn’t. It is doing what it should be doing, and it won’t go to zero. There is a bottom. Prices are adjusting downward but there is a bottom.
As mentioned, compared to one month ago, prices are lower today—and they should be lower due to the economic and earnings hit that will happen as a result of the virus shut-down. Here is a tiny piece of evidence that demonstrates that the market is working. Since the market high on February 19th, shares of McDonald’s are down 29%. For the same period, shares of Walmart are up 2.2%. If you think about those numbers for more than a few seconds you say to yourself, “Yeah, I get it. Walmart is doing great right now as everyone fills their cart, preparing to stay home for 2-3 weeks. Meanwhile, restaurants are really getting hurt right now.” Market prices reflect that. The market mechanism is working. I hope this data is encouraging to you.
Expect more bad headlines in the weeks and months ahead. Because the US just started widespread testing, we will see a tremendous spike in the number of infections in the US. You and I know that we will learn of supply shortages, overcrowded hospitals, and deaths. The situation will seem chaotic and out of control. We will also soon begin hearing from a growing chorus of voices claiming that the “cure is worse than the disease,” that shutting down much of the US economy will push unemployment to unsustainable levels and drive millions of Americans into poverty. There will be tremendous debate about this issue and it will be tumultuous. We must acknowledge that we are going to go through this difficult time and that the headlines will not be good. The market will continue to be very volatile and it may fall further as this unfolds. Much of this is already factored into stock prices but the market certainly can go lower from here. We think it makes sense to tell ourselves that it will.
We are rebalancing portfolios. Because stocks are down and bonds are flat, rebalancing means we are trimming bonds and adding to stocks. We acknowledge that this crisis may drag on for many months, and we are considering the need for liquidity in the portfolios that we are rebalancing. Specifically, if you have a draw on your portfolio, we are considering this as we make portfolio decisions. In many cases, we are stopping short of fully rebalancing the portfolio, electing to maintain a slightly above-normal allocation to bonds to get through this difficult time.
Our Bragg investment committee has been in constant discussion during this period. Like many of you, we have become armchair virologists. We are digging through research about past epidemics, studying the experiences of China, South Korea, and Italy, counting cases, and listening to experts in press conferences. We have found that sharing information has helped us maintain a healthy perspective. Two-thirds of the members of our investment committee were managing money during the tech bubble market decline of 45% (2000-2002) as well as the financial crisis decline of 57% (2008-2009). We find that our historical perspective helps us remain calm as we approach the situation before us. We have also learned that many of you are doing research as well. We want to thank those of you who have sent us very useful information over the last few weeks.
Some of you have asked great questions during conversations we have had. Below are some of those questions and our answers.
Q: Are you buying defensive stocks so we can survive this thing?
Q: Are you buying the stocks that have been beaten up the most knowing that they will have the biggest rebound on the other end?
A: We are doing both. The example used above featuring Walmart and McDonald’s is a great example of something our investment committee has discussed. This example tells us that the market is rational and efficient—and smarter than we are. It tells us not to get cute with our clients’ portfolios by trying to predict which companies will win/lose. We aren’t loading up on sectors or stocks that we think will provide the “most protection as it falls,” or the “most upside when it rebounds.” In the specific Walmart versus McDonald’s case above, we are buying both companies. If we get past this crisis quickly and have a rebound in the economy, McDonald’s will outperform. On the other hand, if this thing drags on for a year or more, Walmart will likely outperform. Over a ten-year period, we think both stocks will be a good investment.
Q: Should I raise cash today by selling stocks and plan to buy back into the market later when it bottoms?
A: This might work. On the other hand, it might not. History has demonstrated that it is extremely difficult to call a bottom. We think there is more certainty in simply hanging onto our shares for the long term. We should tell ourselves that we will be offered very low prices for our shares in the coming months but that we will not sell our shares and that at some point in the future, the price offered for our shares will be much higher. While not as sexy as selling high and buying low, we think holding tight is a strategy that will work. Given a choice between an approach that will work and an approach that might work, we will choose the former, even if it means we endure a lengthy period where our shares are worth less.
No one rings a bell at the bottom. March 9, 2009—the day the market bottomed during the financial crisis—was just another day of depressing economic and market news. There was no indication of a “light at the end of the tunnel.” One was not able to determine “that things have stabilized.” There was no evidence that there was a turn coming. In fact, for more than a year after the bottom, most investors believed that the market would take another turn down and set a new low. Even as years passed, the rising market was described as the most hated bull market in history.
The portfolio plan we have helped you create is driven by your financial plan. This planning is designed to allow you to stay the course. Please click on these two links to read our prior newsletters related to the COVID-19 crisis. In particular, take special note of our comments about liquidity. If you have enough liquidity to get through the crisis, our advice is to stay the course. If you would like to discuss your portfolio, including your allocation and your liquidity position, please let us know.
On a personal note, we want to say thank you to so many of you who have reached out to us with kind words during this period. While my letter is primarily about the economy and the market, this is a time when we are all thinking about people. Nothing is more important than the relationships we have with people we love. During this time of social distancing, our hope is that you are still finding community and support by being in touch with family and friends. We hope that your family stays healthy and that you are able to find peace amid a chaotic time.
Benton S. Bragg, CFA, CFP®
President, Bragg Financial Advisors
Here are links to resources we have found especially useful during this time: