Paladin client portfolios were defensively positioned going into this market downturn, with relatively low equity exposures and a variety of portfolio hedges in place. Even so, the volatility of markets has been a challenge for all of us. Now that state & local governments, as well as large corporations, have gotten serious about the need for social distancing--and the urgent need for community support--we expect investor confidence to improve. The Federal Reserve and Congress are stepping up to provide liquidity to markets and budgetary support to families and businesses affected by the shutdowns. With many financial markets in a severely oversold position, we expect a “trading rally” to unfold over the coming week(s). That’s not unusual; some of the stock market’s best days have occurred during crises.
However, as readers of our letters may have guesssed, we view the coronavirus as a catalyst for market weakness, not the cause. It has revealed deficiencies in market infrastructure and extreme levels of leverage that have been present for a long time—but papered over with central bank liquidity. It’s revealed concentration and fragility in our global supply chains and health care systems that have serious repercussions for our economy and society. It’s revealed the serious consequences of ongoing failure in our political systems. These intersecting and compounding challenges are independent of the virus, and exacerbate the difficulty in confronting it. They cannot be addressed easily or quickly.
- Even with positive seasonal effects on the virus of warmer weather, with no vaccine expected for at least a year it will be difficult to avoid renewed spread, absent longer-term changes in our social and economic behavior. Given the age cohort of our political leaders, we doubt they will allow it to simply “burn itself out” and continue business as usual. Not even in the UK. Even if they try, the public may not cooperate.
- There will be significant supply chain disruptions, as the risks associated with concentrating final production in one country, while distributing the manufacture of components around the world, become apparent. This will have negative ramifications for the earnings of multinational corporations (S&P 500 constituents). These issues are already obvious in medical supply chains, and will become apparent everywhere else soon.
- There was tremendous crowding in US equities and record levels of corporate leverage before this virus hit. Market downturns always unmask weak business practices and financial malpractice. Stock buybacks are already being canceled; we anticipate debt rollover problems in credit markets and continued selling pressure on equities as “trapped longs” try to escape with their shirts.
In sum, the manufacturing economy will be hurt by supply chain disruptions, and the services economy by required social distancing. All this is happening at a time of great fragility in financial markets, when policymakers have spent most of their ammunition supporting the prices of overvalued assets. It is an unstable scenario, to put it mildly.
Many people will assume that when the first wave of virus passes, things will be back to business as usual. We do not. As such, we will use the coming rally to further trim our clients' portfolio risk exposures. We are also on the lookout for new investment opportunities, particularly in the commodity space. However, given market volatility, we are treading lightly.
Paladin has asked our clients to donate their quarterly advisory fees to individuals and organizations in their community who need the funds more than we do. This is a meaningful sacrifice for us (we run lean here) and willingly borne. We are hoping it will be expensive; then we’ll know we’ve succeeded.
Please consider who in your community—it will soon become clear who they are—desperately needs your support. One of the leading science journalists following the coronavirus story, Kai Kupferschmidt is crowd-sourcing ideas. Consider nurses’ associations, hospital janitorial staff, those providing school lunches, small business people, deliveries for shut-ins (meals on wheels) etc. Economic distress will be wide-ranging, and may appear where one least expects it.
So don’t let the perfect be the enemy of the good. All help is good at a time like this.
Let us all give generously, with what we have, from where we are. We are all Paladins.