With this in mind, over the last 12 months the market has gone from extreme greed to extreme fear as measured by the CNN Fear & Greed Index.
As most investors have been glued to the TV to witness the worst sell-off since the Financial Crisis, I think it's important to be aware of our emotions and reflect on what's happening.
As someone who spends much of his time abroad, the coronavirus is serious. Very serious. Many global companies have virtually halted all non-essential travel, and Halo is no different. Who doesn't want to be grounded in Chicago during the winter months...
That being said, the coronavirus has yet to come close to taking the number of lives the common flu has taken this year:
"So far, the new coronavirus, dubbed COVID-19, has led to more than 75,000 illnesses and 2,000 deaths, primarily in mainland China. But that's nothing compared with the flu, also called influenza. In the U.S. alone, the flu has already caused an estimated 26 million illnesses, 250,000 hospitalizations and 14,000 deaths this season, according to the Centers for Disease Control and Prevention (CDC)." - Rachael Rettner, Live Science
What's serious is that the figures above were written just a week ago, and deaths from the coronavirus are now almost 50% higher. We shouldn't discount the severity of the virus, but as investors, we must look at the impact to the global economy. While the rapid increase in deaths is personally horrific by any account, we should also be thinking where the virus is spreading. The virus cropping up in European manufacturing hubs like Italy, Switzerland, and Germany is very alarming. This will make it even harder for companies to divert from suppliers in Asia. One could consider that North America may be in a position to benefit if the continent brings manufacturing "onshore," assuming the continent can keep the virus contained. I believe it will.
It will take some time for the virus to show up in economic data, but inventories and jobs should be two good indicators on how the virus is affecting the broader economy. This is what I am personally following. In the meantime, we should be looking to what executives are saying in the slew of earnings that have been released. Taking Home Depot as an example, earnings were quite positive and management explained they have the plans in place to help mitigate the impact from coronavirus. It was apparent last week technology companies don't...Given much of the recent rally in equity markets has been fueled by tech, this can spell short-term pain for the markets. While the world is digitally more connected now more than ever, as seen by Zoom's impressive rally the past two weeks, Zoom does not help companies manufacture products....IF the virus worsens, this could lead to a virtual shutdown of all production activity, significantly damaging the economy. In short, I believe that the biggest risks to the market are supply, not demand, oriented.
As a result, no monetary measures, whether by the Fed or coordinated globally, can cure a virus. While technology allows us to not have to leave our homes to make a purchase, you can't make a purchase if there is nothing to produce and inventories are dwindled. This is the conundrum Central Bankers face. Lowering interest rates can stimulate the economy on the demand side, but this is a supply issue. I believe Central Bankers are misguided by using monetary tools to cure a virus when the risks are balanced more to the supply side. They need to preserve the ammunition for when recession hits, and it WILL hit, and in the interim use Fed Speak to help calm markets.
Analyzing this further, coordinated intervention may also lead to an unintended increase inflation. If inventories do dwindle and manufacturing can't catch up, you could see a case of increased inflation as demand exceeds supply, further challenging the Fed's position. GIven how low rates already are around the world, Central Banks should be very cautious about being too quick to lower rates for something that could be cured in a relatively short time. In short, don't bet on the "Fed put" to save the world from a disease.
So what does this mean for the markets? Like with any forecast, I don't think any of us know for certain....You can't model extraneous risks like pandemics. What I do know is the market is pricing in virtually zero growth, and earnings estimates are being slashed drastically across the board as company after company halt travel. While there certaintly will be no shortage of doom and gloom discussed, I believe much of the bad news is already priced into the markets.
Taking a look at the VIX chart posted by the Wall Street Journal this morning, one could argue this to be the case.
In my opinion, the market took a much needed breather given the rally over the last 13 months putting valuations at their highest since 2002. Given the depth and breadth of this sell-off, I believe the market presents an attractive entry point to start deploying some of the cash investors have accumulated on the sidelines. While there could be more room for downside even after Monday's intervention, investors should consider Structured Notes that offer a level of downside protection against further declines while locking in some nice fixed returns as a way to combat these challenging times in the markets.
One way to take advantage of the uncertainty is through income-oriented Structured Notes. Over the last week I have bought income-oriented Structured Notes on major Indices, where I receive a fixed return, paid out as a quarterly coupon, as long as the referenced Indices are not down by more than 30% from purchase on the coupon payment date. On Friday, I was able to lock in almost a 12% per annum yield on a 4 year Structured Note linked to the worst performing of the S&P 500, EuroStoxx 50 and Russell 2000, with 30% soft coupon and principal protections against market declines.
These types of products are currently interesting to me for a few reasons:
1) The Yield - The yield is very compelling to me. Given the Note is linked to equity indices, this particular Note should be classified as Global Equity in the portfolio given the global nature of the referenced indices. I used cash that was earmarked for equities to fund this Note. As many of my readers know, I target a 6% per annum return in my portfolio and this Note fits the bill. I believe it will be difficult for the market to produce a higher annual return than 12% over four years, which is another reason why I found it so compelling. It's important to understand that with income-oriented Structured Notes, the coupon gets higher the higher volatility climbs. Through the purchase of this Note, I am "selling" volatility near its historical highs over the past 5 years as we can see from the chart above. While this is a more tactical reason to buy the Note, it is opportunistic nonetheless.
2) The Protection - Not only do I have the opportunity to lock in a nice yield, this Note allowed me to obtain 30% downside soft principal protection from these levels. I have the thesis that in four years time, none of these indices will not be down more than 30% from current levels. Moreover, I do not believe these indices will be down by more than 30% on the coupon payment date. If they are, I lose the coupon that was owed to me for that period, but nothing happens to my future coupons or principal.
3) The Sideways - I have been talking about a volatile market for sometime, and the market has not disappointed. Dating back from 2018 we have seen some wild swings on the up and the down. I am always looking for some more "stability" in my portfolio returns, and this Note can be a good way to reduce the risk of my portfolio while locking in a nice annual return, contingent upon the reference assets not dropping below the coupon protection amounts. While Structured Notes can be used in many ways within a portfolio, I certainly believe that combating a sideways market is one of the most powerful applications.
To this point about sideways markets, the world is at an interesting inflection point. The economy is doing well, but there are certainly some cracks in the armour. Job growth and housing are strong, but inflation and wages remain muted. As we enter an election season, fighting a global trade war, in the middle of a late economic / market cycle, and asset valuations near historical highs on many metrics, this is one of the most challenging investment environments I've seen since the Financial Crisis. It doesn't help that bond yields continue to drive to all-time lows. Throw in a pandemic with coronavirus, it's easy to understand why stocks, bonds, and gold have all been showing different signals. It's time to buckle down.
The simplest advice I can offer is to focus on the broader economic fundamentals, not the short-term fear of a pandemic. Don't try to catch a falling knife, but consider ways to leg into attractive entry points, as we're seeing now. Structured Notes can be one strategy to consider so you don't expose yourself too much if there is more pain to come, but can capture the upside if this indeed a blip. For humanity's sake, let's hope that coronavirus is indeed a blip.
Good luck, stay safe, and as always, Halo is here to support your practice and help your clients sleep a little better at night.
Halo Investing - Knowledge Center : Market Trends