And Now Something About What's Happening in the Markets

There's just so much being published out there about our wild financial markets. We've rarely sent updates to clients that include commentary about what's going on. Frankly, most of that sort of commentary is pretty uninformative, even boring. In fact, even with all that's going on, a lot of commentary put out by mainstream major financial institutions sticks to the pattern of being mostly uninformative - with some exceptions.

These last weeks, I've had to hash through an unusual flurry of input from our "brain trust" - the trusted source we pay for insights into what's going on in the markets. In addition, I've selectively read pieces that have some merit - either because I know the author, or simply because they're part of the usual "sampling" I do of what flows through my laptop. It's been a struggle to process it all. Even harder, condensing it into a form that might be informative and helpful to our clients. With that in mind, here's what we finally sent out to them Friday night, for what it's worth:

Markets

A couple of years ago, one of our paid expert sources predicted that swings of 2,000 - 3,000 would eventually become common during volatile periods. I filed this away for future reference. When those 2,000 - 3,000 point drops arrived I was able to check my mental file drawer.  Being mentally prepared was helpful in not over-reacting to the unfolding drama. That, combined with our risk management discipline (more on that below) provided invaluable assistance in the form of mental and emotional stability as we watched the wild price swings. 

The large swings up and down, if they do eventually subside from extreme levels, will likely not go away. We should all be prepared for this possibility.

The selling action we all witnessed reflected the fact that a credit crisis has arrived. The Fed therefore announced an emergency plan to pump “liquidity” into the financial markets to avoid the sort of credit freeze-up that triggered the 2008 crisis. This included dropping the Fed Funds rate 100 basis points (1%) to, essentially, 0%. A cut of 1% all at once had never been done before.

In fact, after some cursory research, I’m pretty sure the Fed has not taken an action on a weekend since 1979 when Paul Volcker announced the Fed would take any and all actions necessary to stop what was then rampant inflation (41 years ago). That announcement didn’t stop inflation on a dime. There followed a period of 3 years of extreme volatility in the gold, bond, and stock markets. Eventually, though, inflation was tamed. And the troubled stock and bond markets stabilized and began decades-long general up trends. 

I'm not saying it will take 3 years for the Fed’s actions to result in something positive. Indeed, they have come out with an additional monetary stimulus package that really didn’t garner the attention it deserved - perhaps because our headlines are obsessed with daily reporting of the cases of COVID-19 along with the numbers of people who have died as a result of the virus. Without diving into the details of the Fed’s subsequent announcements, the phrase that sums it up best would be “QE to Infinity.” 

QE stands for quantitative easing. That’s basically the Fed creating money out of nothing to purchase treasury securities from various financial institutions. This practice never existed prior to the 2008 crisis. The Fed initiated these purchases to inject money into the financial markets, with the belief that it would trigger and economic recovery. While it arguably did stem a financial collapse (according to some), the economic recovery they expected really never unfolded. It seems their revival of this round of QE is intended primarily as a defensive measure.

As for the phrase, “QE to Infinity,” an analyst we follow began using this term a number of years ago. He was trying to make the point that, at some point in the not-too-distant future, the Fed would be forced to remove all limits to what is essentially money printing in order to save an economy and financial system that, more and more, was built upon massive borrowing. “Money printing” would be the simplest way to understand what the Fed is now up to. And they’ve committed to pursue this without limit. But in addition to purchasing guaranteed US treasury securities, they are instrumental now in purchasing corporate bonds and other non-guaranteed securities. Unprecedented. Again, “QE to Infinity.”

Where all this leads remains somewhat of a mystery. We can speculate, but it’s not worth spending too much time with that for now. Instead, we focus on what we can do to minimize potential losses in our portfolios, along with recommending measures that we can take to bolster our financial immunity, much as we have discussed ways to bolster our bodies’ immunity during this crisis.

Of course, as we know,  there’s no guarantee that attempting to build immunity to defend us from this virus will prevent us getting sick. In the same way, there’s no way to guarantee or measure with assurance how effective will be our attempts at immunizing our portfolios. But just as bolstering our immune system will help us fight the virus if we catch it, so too taking measures to immunize our portfolios will help them survive the current crisis in the financial markets. We forge ahead best we can with those efforts. As an expert in physical exercise I follow famously says, “Do your best and forget the rest.”

To that end, we focus our attention and efforts on risk management. We have developed a risk management discipline over the years. Under normal circumstances it helps minimize losses without unduly getting in the way of potential gains. That discipline should provide some measure of protection even in the current crisis.

While we cannot avoid losses in our portfolios, losses to date have remained within the parameters of the various models against which we monitor them. On average, losses for fully invested portfolios come in between 10%-11%  year-to-date. 

No one likes losses. That’s why all our portfolios utilize a combination of risk management disciplines. The two most important are: a) Month-end indicators that can trigger selling and/or buying for our major Core positions; b) Trailing stop-losses for certain individual positions that are part of the Variable/Speculative portion of most portfolios. 

If you received trade confirmations in the last few weeks, those would be due to trailing stops that caused us to sell those particular positions. Trailing stops are intended to minimize losses. They did that. Our Core positions remain intact, although we did trim some of our long-bond positions after they rose parabolically in the initial stages of the stock sell-off. We took some profits to build our current cash position.

Now we look forward to our end-or-month indicators coming up this Tuesday (3/31). They will help us determine whether we need to make adjustments to our Core positions. 

The point of all this is to remind you that we do have an active risk management discipline to minimize losses - with the emphasis on “minimize” rather than eliminate. No one can eliminate losses in these sorts of markets. They come - fortunately rarely - with the territory.

We should anticipate continued extreme volatility in the markets and a continuation of the now-familiar consequences of this Coronavirus. You can also anticipate further updates.