I’m sure you saw the headlines:

“Record Economic Plunge”

“Second-Quarter GDP Plunged by Worst-Ever 32.9%”

“U.S. Economy Contracted at Record Rate Last Quarter”

It sure sounds like the sky is falling.

August-7 The sky isn’t falling, Chicken Little at your earliest convenience

Is it really? Let’s take a step back and put the news in perspective.

The coronavirus shutdown thumped the economy, businesses, and workers badly over the last two quarters, and it’s uncertain how quickly we’ll recover.

We knew that Q2 GDP numbers (Gross Domestic Product) were going to be horrible. In fact, in May, the Federal Reserve thought they were going to be even worse

So, ~33% down is actually better than expected. Think of the D student getting a C as a grade.

But, despite the headline, we didn’t actually “lose” 33% of economic production last quarter. The Commerce Department reports data on an “annualized” basis to make it easier to compare; so, if you looked at it quarter-over-quarter, the economy lost 9.5% since Q1.

These are simply acorns falling on our heads, not the end of the world. There are many people in the media playing the role of Chicken Little, you have to ignore them. Our job, as investors, is to have courage even when it feels like, and others are saying, the sky is falling.

The largest contributing factor to the economic losses was a steep drop in personal spending, particularly on services, which makes complete sense in a shutdown. It is hard to go out for dinner or cocktails when restaurants and bars are closed.

Three points before we move on:

  1. This is an advance estimate for Q2, and we will see revisions as more data is finalized.
  2. Though this is the sharpest drop in the shortest time in history, it was caused by the shutdown, and we’re already climbing out of it.
  3. 63.8% of economists think Q3 is when we’ll see the recovery really pick up steam, and the current forecast is for 15.2% annualized growth this quarter.

So, what does that mean for my portfolio?

I think markets are being driven by a few big trends.

In a previous note, I mentioned what a Nobel-laureate economist calls “FOMO mania” by investors who fear missing out on the bounce. I think that is still in effect as investors continue to pile into stocks, especially in the tech sector.

I also think the market is being supported by massive government spending and Federal Reserve intervention.

And thirdly, I think a lot of traders are betting heavily on the recovery. If states have to shut down again, the collective delusion may collapse and trigger a correction. We’re watching for that.

How long will the rally last?

That’s anyone’s guess. I’ve seen many cheerful forecasts predicting new all-time-highs. I’ve also seen plenty dolefully predicting the next crash. It seems to depend on the channel and the political bias of the person talking.

With so much unknown, they’re all guesses. Even in less-murky circumstances, the “market gurus” on CNBC and in the financial press are only accurate as often as The Weather Channel is at predicting hurricane paths. Hint: not very.

So, since we can’t predict what’s going to happen in Q3 and Q4, we’re staying agile and focusing on the fundamentals of good planning. We completed a rebalancing in July of all managed accounts to bring them into proper risk alignment. We have been speaking with clients to make sure they have ample cash on hand for the rest of the year’s expenses. If you had some future expenses come into view recently, please reach out to us to make sure we look at your cash reserves.

I know, it’s a really boring answer but it works. Investing legend Seth Klarman has a great quote that I think about a lot as it relates to portfolio management.  “Investors need discipline to avoid the many unattractive pitches that are thrown, patience to wait for the right pitch, and judgement to know when it is time to swing.”

Having a defined risk management process is how we give our clients the best opportunity for success in chaotic times. It protects the downside first (rule number 1) and allows us to participate in the upside since we still have the majority of our principal intact.

If you know someone who has not fared as well as you this year, please feel to pass our information along to them. 

Thanks again for the trust and confidence you place in us.

Warmly,
Michael