Last quarter I wrote that I was optimistic about our country’s ability to weather a crisis like COVID-19, and while the last 3 months have been challenging, we are beginning to see light at the end of the tunnel. Unlike most recessions, we just experienced a “planned” recession, meaning that a structured reopening was always part of the plan. While monetary and fiscal stimulus have underpinned this recovery, we are starting to see signs that the economy is beginning to turn green of its own accord.
For sure, equity markets bounced back more quickly than most analysts anticipated. In physics, Newton’s third law states that, “for every action there is an equal and opposite reaction.” In many ways, this law could be applied to the stock market. We experienced a historic drop in March, and it was not out of the question that we would see a quick rise on the other side. However, the approach to handling the medical side of this virus and to concurrently not inflict severe, long-lasting damage to the economy, has been a road strewn with much controversy and varying degrees of success.
From an economic standpoint, the biggest risk to the recovery is a continued shutting down and reopening of the economy on a national basis. While we are modeling this scenario, it seems more likely that the risk will be geographic in nature. As of this writing, while new cases are increasing, only 6% of the counties in the U.S. are in the “red” zone. These are predominantly in the South and West and these states are actively taking action to reduce the spread of the virus.
Some of you may be unaware that we model many scenarios for potential economic and market conditions. We use this tool to assist us with risk mitigation in the portfolios. For example, we carried more cash in portfolios than we usually do during the downturn in the second quarter. You may have noticed that some of this cash was reinvested as we determined the potential risk of a second national shutdown continued to decline. However, we have also reduced risk in the fixed income pieces of the portfolios in conjunction with this reinvestment. We have implemented a truly multi-tiered approach as we weather this storm. A second national shutdown is not completely off the table; however, the risk has declined, and we are now evaluating the disparate effects the early recovery has had on each individual sector.
Looking forward, we anticipate the remainder of this year to be volatile. While we would not expect another 25% or 30% drop in the markets, we would expect to see 5% - 10% fluctuations as we are faced with economic, social and political events. In addition, while we see the economy continuing to strengthen, our timeframe has altered a bit. Our analysis indicates that the positive trends we see have a decent probability of continuing, and while we were hopeful that we would regain the ground we lost by the end of 2020, it appears this will not occur until the first part of 2021. We anticipate this trend to continue through 2021 and into 2022. Again, the risk of a wider shutting down of the nation could cause this forecast to change.
We have positioned the portfolios accordingly throughout this year and are satisfied we took the right actions. We would be happy to discuss in more detail if you have any questions. Thank you very much for your continued trust.
Marc Henn, CFP®