Steve Chiavarone: Hello, and welcome to the Hear And Now podcast. I'm Steve Chiavarone, Portfolio Manager and Equity Strategist at Federated Hermes. And today I'm joined via phone by Phil Orlando, Chief equity Market Strategist. Phil, thanks for joining me this morning.
Phil Orlando: Pleasure to be here. Thanks for hosting this.
Steve: We've been in the trenches over the past couple of weeks trying to understand and respond to the dislocation that's being caused by the coronavirus outbreak. And my hope today is that we can share some of our best and most current thinking with our listeners. So with that, let's jump in. Phil, you've been through your share of market cycles. How does this one compare versus prior events? What's different? What's the same? Give us some thoughts.
Phil: So I've got a lot of gray hair over the last 40 years, and this is probably the fifth major crisis that I've managed through as a professional. The economic double dip in the early '80s, the Black Monday debacle in '87, the bursting of the tech bubble and the 9/11 terrorist attacks in '00 to '03, the housing bubble bursting in the great recession, '07, '09. And here we are now with COVID-19. I would respectfully suggest that this situation that we're dealing with is worse than all of them combined. And you can probably throw in Hurricane Katrina and Super Storm Sandy into the mix. So it's an extraordinary set of circumstances. And I think we're going to manage our way through this. And I think I see a light at the end of the tunnel.
Steve: It's interesting, Phil, you mentioned Hurricane Katrina, Hurricane Sandy. We've been using this hurricane analogy in our own analysis, because a hurricane or a natural disaster, it's the only thing that really comes to town and shuts down an entire economy. And I think some of the fears are similar, right? Before a hurricane hits you know it's not going to last forever, just like the virus, but you don't know how long it's going to last, you don't know how bad it's going to be and you don't know what damage is left in its wake, much like what we're dealing with right now.
Steve: But I think one of the things that's been interesting is when we have these natural disasters, it's a city or a town or even a state. Now we're trying to take that model and gross it up nationally in terms of the kind of loans that you would provide to businesses or the emergency relief funds or the bridge financing. So it's ironic that in all of those examples that you mentioned, it's the hurricane example, kind of on steroids here that may be the most appropriate. What do you think?
Phil: Well, I think it is appropriate, but I don't think you've gone far enough. Yeah, we're talking about here in the United States through social distancing, we've shut down a bunch of states: California, Illinois and New York among them. But we're talking about shutting down the world or parts of the world based upon the infection. And given the fact that we are in an economic environment where globalization is an important element of that, I think the hurricane example is an apt one. But you've got to widen your purview to include the entire global economy.
Steve: Yeah. If I would add to that, I think one of the things that we've learned so far, which in retrospect isn't all that surprising, is when you try to gross that up normally you have banks making loans to small businesses after a natural disaster. It doesn't quite work. Certain things break, if you will. So for example, in trying to support and provide bridge financing nationally or globally, we've seen that banks don't really have the capacity to lend to all small businesses, all corporate borrowers, all state and local borrowers, and the energy patch all at once. And we've seen some cracks form in the credit markets that the Fed has then come in to try to solve. And I think it's become really interesting here is that what you've needed is the borrower of last resort, which is the federal government, to provide a sufficient amount of emergency relief spending. And you've needed the lender of last resort, the Fed, to provide liquidity to give you that bridge funding to essentially allow companies and individuals to get through this without causing too much damage.
Phil: That's a really interesting point, Chevy, because the questions that we're getting from clients right now who are certainly confused, and in many cases scared, is okay, how do you analyze this? Now, in a normal environment you'd say, okay, stock market's down 35%, let's take a look at technicals. Well, technicals aren't working right now. The technical support levels, we're running through them like a hot knife through butter. Well, what about fundamentals? Well, with companies basically shutting down, with workers being encouraged to shelter in place, you've got no real economic activity or revenue or earnings activity that you can monitor. So a lot of companies within the S&P 500 are withholding guidance.
Phil: So in that environment, with no fundamentals, no technicals to rely upon, how are we as investment professionals supposed to analyze this thing? And I think what we've done is created this frameworks with three key elements that I think are actually very helpful. Monetary policy. What is the Federal Reserve doing? And I think we can agree that they're sort of all in here. Fiscal policy, what's going on in Washington. We've gotten the first two phases of legislation through, and we're currently going through the process of approving that 2 trillion dollar third phase. And then finally social policy, are things like social distancing and hand washing, working.
Phil: What is the response coming in to the biotechnology community in terms of either repurposing existing drugs or coming up with new compounds or methods of testing that will help us get through this? I'd like to say that I think we're doing pretty well. That certainly there's some chop, there's some uncertainty here, but this framework we've developed is giving us a sense of how this environment may play out.
Steve: Phil, let's zero in on that monetary and fiscal response element here. In particular, we've really resisted the term stimulus here, because what we've said all along is that this is bridge financing interestingly. So what do we mean by that?
Phil: Well, I think very simply that you've hit the nail on the head there, that this isn't stimulus because we're encouraging people to just go home and lock their doors and not do anything. So we're trying to create this bridge financing idea, at least in my mind, to how do we get them over the hump for the next couple of weeks or the next couple of months until their companies or their businesses come back?
Steve: Well, and I think that's key because remember we came into this with a very strong economy, right? So we had this strong economy, you have this act of God, if you will, this disruption that has nothing to do with the underlying economy. And what we're trying to do is preserve as much of the fabric of the economy during the storm, if you will. Because if companies are able to stay alive and workers stay connected to those companies, once the virus passes it's easy to get those folks back to work.
Steve: But if the companies go out of business in the meantime, then there is no place for those workers to go back to work. And then there's bad loans for the banks, et cetera. So I think some of the measures on the fiscal side, particularly the loans to small businesses and the support for key industries, is critical here because it should allow, if effective, for a quicker and stronger recovery on the back end. And as we think about size, on a 20 trillion dollar economy, a quarter is worth about 5 trillion dollars of activity. What we're seeing something akin to 2 trillion dollars in bridge, in emergency relief funding from the federal government once they pass this phase three plan, and something close to 4 trillion in liquidity measures from the Fed, which we're starting to get in the ballpark, right?
Phil: Well, and don't discount the fact that Mnuchin and Kudlow have talked about the way they're thinking about this 2 trillion dollar emergency relief act that's winding its way through Congress. Now they're thinking of the ability to lever this up. So while it's 2 trillion dollars on the surface, they think it could be worth many times that. Again, in addition, as you said to the Federal Reserve essentially doing unlimited QE, having cut interest rates from 175 basis points down to a zero to 25 basis point range and the Fed Funds Rate, providing a backstop for commercial paper. I mean the Fed's all in. And now the question is can we get fiscal policy to catch up with monetary policy? And how effective, how well constructed, how targeted is that legislation going to be?
Steve: Yeah. Now, to be be clear, right? While we've been constructive on the response that doesn't mean that we're underplaying how bad things will get. I've been using the line as an example that the virus data is likely to end up at its peak to be 100 times worse than now. Economic data is likely to be 10 times worse. I think we've gotten the first taste of that this morning with unemployment claims going from 280,000 a week ago to something closer to 3.3 million today. 3 million people lost their jobs, or three and a half million almost.
Phil: Just to put that into perspective, the highest weekly claims number we had ever seen in the history of the United States was 695,000 back in the early 1980s. So this number today at 3.3 million was, like you said, substantially above that. And that number could get bigger over the next couple of weeks.
Steve: Yeah. And I think the point is, is that we're constructive on the medium to long term, not because we don't think the next quarter is going to be bad. I mean, in my personal opinion is we're likely to see the worst quarter of economic growth on record, maybe the worst quarter that any of us will see in our lifetime starting now. In that environment A, how do we stay constructive and clear headed and not become simply overwhelmed by that data? And two, how do we think about a bottom?
Phil: Well, bottoming is a process. Point number one. Number two, the equity market as a forward looking discounting mechanism is trying to look out six to nine months and predict the future. All of that clearly is very difficult to do.
Steve: I'm a big fan of looking at history for guides going forward. If you look at the history of pullbacks this is one of the deepest and the fastest certainly. But outside of the great depression example, where you had policy failures and bank failures, et cetera, even the worst pullbacks had been somewhere in the 50% to 60% range, no worse than that. At our bottom here we had hit 35%, so it strikes me that under most circumstances we've seen... If we haven't bottomed yet, which is I agree with you, I think we at least retest that levels if not break to new lows, but that doesn't mean that just because the economic data is going to get 10 times worse and the virus data's going to get 100 times worse or the market's going to get 100 times worse. I think we've probably seen the bulk if not all of the downside.
Steve: I've been encouraged by looking at those big pullbacks that have occurred in what was otherwise a secular bull market, 1969, 1987. Those pullbacks were of similar magnitude and that 35% ish range, they were painful, they were scary. But ultimately you did bottom over the course of a couple of months, you did recover, and you were able to get back to the old highs somewhere around two years later. Who knows if that'll happen, but it does beg the next question. What kind of recovery are we likely to look at? Is it something that's going to be very fast? Is it going to take some time? I mean, it's clear that in an environment where we're going to be putting the kind of GDP numbers that are likely to come out and the unemployment claim numbers that we're already starting to see, that there is some damage that's going to be caused to the underlying economy. Let's share some of our thoughts about what that eventual recovery might look like.
Phil: So the conventional wisdom is that there are three potential paths from this point forward. There's the so called L bottom in which the market has had this sharp decline. And then we're in this massive global depression and we go sideways off of that base forever. We don't think that's going to happen. There's the V bottom recovery where you've had the sharp move down and you have a bounce and you have the sharp move up. While that's possible, less likely.
Phil: I think the most likely case as we see it at Federated Hermes is the so called U bottom recovery. That you've had this sharp move down, you're going to have this bottoming process over the course of a couple of weeks, maybe a couple of months, and then you have this nice recovery. So if I'm given the luxury of looking out say over the next two years or so, I think we're going to be in pretty good shape. I think we're going to be back to where we were before all of this went to hell in a hand basket. But you've got to have the luxury of time and the patience to be able to let this play out and let the policy response work over the next two years.
Steve: Yeah. I think we're very much on the same page there. And I think what's interesting about market bottoms and the recovery is the market is a discounting mechanism. It is very likely to start to rebound before the economic data starts getting better. And probably around the time of the virus peak rather than needing the virus to go away. So when those daily new cases peak and then start to roll over, that's something that I know we're watching very, very closely. I mean, so far, at least today, with this terrible claims number we're seeing the market rally on that. I think that's a good sign. Market rallies on bad news are a classic feature of the start of trying to find a bottom.
Steve: I want to get to our last topic here, which is the advice that we're giving to our clients in how to navigate this. I know for me I'm always reminded... I'm fairly certain that no one other than having the good fortune of a mistake went out and sold all of their market exposure on February 19th at the market high here. And I'm also fairly confident that outside of a mistake no one's going to be able to go all in at the intraday bottom of the lowest level that we'll see prior to the recovery. What is the advice we're giving to clients now about should they be buying, should they be selling? And then how does that frame of mind advance as we move forward in this process?
Phil: From my perspective, the advice is multifold. Point number one, importantly, breathe, take a deep breath, relax. We're going to get through this. As horrific as this seems, we're going to get through this. Now, I have zero confidence that, as you said, we're going to pick the absolute bottom. But if you're an investor with a longterm perspective, averaging in, putting additional money to work over this bottoming process makes sense. And again, take that longer term time horizon, that perspective that we've been through horrific problems over the years. The terrorist attacks on 9/11, the bursting of the tech bubble, the great recession. We got through all of those things. We are going to get through this as well.
Phil: The resilience of the American people, the spirit of the American people, is unparalleled. We're going to do fine, but we've just got to stick to our knitting. We've got to maintain the social distancing. Let the Fed do their job. I think Washington has gotten their wake up call. I think they're starting to get in the game here. We're going to get through this. So just be calm, breathe, average in, and take a longer term time perspective. And I think we're going to be fine.
Steve: Yeah. I couldn't agree more and echo those thoughts. I mean, right now, especially given the rally we've seen over the last couple of days, I think the first course of action for our clients is to hold the line. Hold the line, meaning look, you've taken some downside on the market. Normally you have an opportunity to get into the mode of protecting capital. Economy is slow over time, you get into recession, markets fall. We were robbed of that opportunity because markets fell so hard so fast here. So you do need to get your mindset back towards making money up on the recovery rather than trying to protect capital on the last few percent down. But our view right now is hold the line. Don't do anything. See how the stimulus comes in. Watch the viruses. And then as we do that retest that we think is likely to come, start to average in over time. Because averaging in is your best chance of getting at least close to that bottom.
Steve: But ultimately, yeah, I mean I think it's very important to remember that we came into this with a very strong economy. We have policymakers that appear to be doing everything they can to give us the bridge financing to get to the other side of this. And I think you're going to find that somewhere around these lows you're going to get a buying opportunity that's going to help you achieve your long term financial goals rather than panicking at the bottom and putting those goals in jeopardy. Phil, any closing thoughts before we wrap up here?
Phil: Just be confident. We're going to get through this. The more important thing is to just make sure that you're safe, that your family's safe, that everyone is healthy. The financial issues are secondary, but not unimportant. And if you just maintain a patient longer term view and just work with your financial advisors, you're going to be able to get through this and we're going to be stronger on the other side of it. So good luck to us all.
Steve: Phil, thank you. Thank you to our listeners. And then as a final note from me. Hey, we are all in this together. As a macro team here at Federated Hermes we want to make ourselves available to you as questions come in. We look forward to being able to see all of you, both our colleagues within the firm and then our clients and friends outside the firm as soon as we can. We look forward to joining you again soon on Federated Hermes Hear And Now Podcast. Stay safe. See you soon.
Disclosure: Views are as of March 26, 2020, and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. No method of investing can assure a profit or protect against loss in declining markets. Federated Advisory Services Company. 20-30116 (3/20)