By Bryan Perry

March 17, 2020

On Sunday night, for what can only be viewed as a pre-emptive measure to keep markets from seizing up, the Fed went ahead and slashed the short-term benchmark rate by a full 100 basis points, taking the Fed Funds rate to 0.00%-0.25% in a dramatic move. In addition to the rate cut, the Fed re-started QE, purchasing $700 billion worth of Treasuries and mortgage-backed securities while striking a deal with five other central banks to lower their rates on currency swaps, making U.S. dollars, the safe-haven currency in times of crisis, cheaper for banks around the world and to keep global financial markets functioning in an orderly manner. Equity markets are viewing these moves on the part of the Fed with great caution and trepidation, as the phrase “emergency action” has investors clearly spooked.

The President’s travel ban on all European flights and a possible yet-to-be-announced quarantine on U.S. hotspots, as they are called, with a high propensity of widespread outbreak of COVID-19, will only provide more anxiety to the investing public. The hour-by-hour updates being fed to us by media outlets show the worst of the virus has yet to be felt, with Europe clearly seeing the fastest rise in caseloads.

Just how serious is it? Well, the Irish government is considering extra restrictions on pubs after footage of bars filled with drinkers in defiance of guidelines, according to Finance Minister Paschal Donohoe. Industry groups say it’s impossible to police all guidelines, and they expect an imminent shutdown on St. Patrick’s Day. This could spark massive hoarding of Guinness beer and Jameson Whiskey!

As the world rapidly comes to terms with how best to cope with the onset of COVID-19 and the difficult course it is taking, before it is ultimately arrested and eradicated, the open-ended discussion of how deep and wide the impact will be on business conditions remains full of unknowns.

As of last Wednesday, March 11:

“The Conference Board’s economic forecast assumes that the number of cases will peak in April and then begin to diminish. Under this assumption, we expect a sizeable disruption to certain areas of the economy over the coming two to three months – most notably travel, tourism, and entertainment activities, which account for about 7% of GDP. Other sectors, such as restaurants and industries, which are heavily dependent on global supply chains, are likely to suffer as well.

“In particular, we forecast consumer spending to contract by 1.7 percent in Q2. Combined with other impacts, real GDP growth is expected to contract by 1.0 percent that quarter. The economy should begin to return to its long-term trajectory in the second half of 2020 as consumer spending rebounds. For the year as a whole, some significant economic damage is done as we expect real GDP growth to fall to 1.4 percent from 2.3 percent in 2019. But currently we see a full-fledged recession as the less likely outcome for 2020.”

This analysis feels about right for now. Time will tell.

US Economic Forecast

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Having just traveled the 100 miles to Washington D.C. from my home in Richmond, VA last week, my railroad car on Amtrak had only six people in it. Union Station near the U.S. Capitol was sparsely occupied with travelers, and there was no one buying from the food trucks anywhere along the streets. I feel for these vendors and all the other “little guys” that are getting crushed by the vacant city streets.

What seems to be a more pressing matter is how the Fed plans to fight what are now fresh deflationary pressures brought on by the sudden impact of the global slowdown in economic activity. Back on January 5, ECB President Mario Draghi told a conference in San Diego that the Eurozone risks falling into a Japan-like funk, which translates into negligible growth, low inflation, and zero interest rates that do little to revive things. “I believe that for the euro area, there is some risk of Japanification,” Draghi said.

Fast forward to this week, and Europe is now in recession – there is no way to put any other spin on it. There will be at least two, maybe three quarters of negative growth for the Eurozone depending on several factors, the greatest being coronavirus. This new reality has put European stock markets in a vulnerable position, whereas the trajectory for the U.S. economy was booming right before the virus hit and thus the U.S. economy can stage a brisk rebound if signs of virus caseloads plateau.

The bad news is that the U.S. risks its own funk. At the same January 5 event, former Federal Reserve chair Janet Yellen talked of secular stagnation in the U.S., an outcome on which former Treasury Secretary Lawrence Summers has long opined. They worry that conventional tools that used to boost growth – particularly easy central banks policies – lose potency, as has been the case in Japan since 1990.

The stock market has been addicted to financial steroids and needing ever-bigger doses to keep up appearances of being healthy. This was the year when earnings growth would justify the performance of 2019, when the S&P suffered four straight quarters of negative earnings growth. Now, without a speedy recovery, the U.S. risks falling into a secular trend of flatlining growth and flat consumer prices.

The current relief package (H.R. 6201: “Families First Coronavirus Response Act”) unleashes $50 billion to target medical needs and provide a financial bridge to small businesses, but it doesn’t move the economy forward. It isn’t clear if and how there will be assistance to the devastated airline, hospitality, and entertainment industries, but it’s safe to say the extra $1.5 trillion in capital injections the Fed announced on March 12 virtually opens a firehose of credit lines to these and other stressed businesses.

According to The Wall Street Journal this past weekend, “Investors are fleeing stock funds at the fastest pace since the bruising market selloff at the end of 2018, while racing into government bond funds at a record clip. They pulled $47.4 billion out of global stock-focused mutual funds and exchange-traded funds in the three weeks as of last Wednesday.” Inflows into Treasuries topped $26 billion. The only period to ever see larger outflows was a stretch in 2008, in the midst of the financial crisis.

However, the outflows from stock funds for last week were “only” $4.7 billion, by far the slimmest drawdown during the current market slide. So, just maybe we’re finally seeing some seller exhaustion –Friday’s late rally would tend to support that notion. It is shocking to see how each time – in 2000, 2008, 2016, and 2018 – the stampede to the exits by investors preceded the next major rally phase for equities.

With this climate of selling everything – and then asking questions later – what does this backdrop mean to investors that desperately need investment income, or even those that don’t need income? Well, after the forced liquidation of all 11 sectors that make up the S&P 500, I would argue strongly that careful stock selection within the Consumer Staples (XLP), Health Care (XLV), Real Estate (XLRE), and Utilities (XLU) sectors is a prudent path to take.

Within the top 10 holdings of each of these ETFs, one can find stocks that pay dividend yields north of 3%, with some paying above 5%, all with bullet-proof balance sheets. We’re also talking qualified dividends (ex-REITS) taxed at a maximum rate of 15% for those with incomes under $425,800 and 20% for those with reportable income over $425,800. Assuming the 10-year Treasury stays around 1.0%, investors can receive three times that yield at a capped tax rate in addition to long-term capital gains.

This is a winning formula for managing the market slump while taking full advantage of the disparity in yield between Treasuries taxed at ordinary rates and defensive blue-chip stocks with growing dividends.

Weekly Sector Performance

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

In a world where forward price deflation is likely to exist, the four sectors noted above will likely endure in the months ahead much better than the other seven sectors due to their recession-resistant nature. They provide the things we need, not the things we want – a winning formula in trying times like these.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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