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Quarterly Market Commentary Q1, 2020The Coronavirus Market Impact An Oxford Harriman & Company Market Commentary
Q1 Quick Summary
• Global equities were down across the board as investors priced in the likelihood
that COVID-19, and related containment efforts, will likely cause a global
recession. The uncertainty surrounding the disease’s global spread complicated
economic forecasts and clouded earnings & GDP visibility.
• During Q1, the MSCI All Country World Index lost 21.3%, while the S&P 500
Index fell 19.6%. Also, non-core bond segments lost considerable value as most
risk-assets experienced panic selling pressure. Of note, the Bloomberg Barclays
U.S. High Yield Index lost 12.7% and the Bloomberg Barclays Investment Grade
Corporate Index fell 3.6%. The sell-off across most risk-asset segments occurred
faster than the economic crisis during 2008.
• The 10-yr Treasury yield ended the period at 0.67%, an all-time low.
• U.S. fiscal policymakers worked to offset the virus-induced economic damage
by rolling out a $2 trillion economic relief package, and the Federal Reserve
dusted off 2008-era market support programs. Relative to 2008, fiscal and
monetary action materialized much more swiftly.
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Shock to Economy and Markets
As COVID-19 cases emerged globally from east to west a material health crisis
was transformed into an economic shock as world governments enacted strict
containment policies and shut down many sectors of their economies. The
precipitous rise in the number of coronavirus cases globally and the uncertain
extent of the economic damage led to panic in markets, as well as forced selling
of financial assets. Nearly all risk-asset prices came under pressure during the first
quarter as correlations converged. Selling pressure was indiscriminate, which left
Treasury bonds and cash as the lone safe havens. Even gold prices fell sharply as
investors reached for all available assets in an effort to raise cash.
In fact, the speed of the risk-asset drawdown was faster than in 2008 as equity
markets reached correction territory (-10%) and bear market territory (-20%) in
record time. Historically, equity corrections and bear markets have taken months to
develop. During this drawdown, major equity indices reached bear-market levels in
a matter of days.
Economically, disease containment efforts have caused most economists to slash
Q1 and Q2 GDP growth expectations in the U.S. and globally. Unemployment
rates are expected to rise dramatically as well, with depression-like U.S. readings
expected. We believe U.S. unemployment rates could peak above 10% and exceed
levels witnessed during the global financial crisis. However, many forecasters
are indicating a material economic rebound may follow in the third quarter. Any
recovery should remain dependent on the length of government containment
Quarterly Market Commentary Q1, 2020
The Covid-19 crisis effects on financial markets have been swift
and severe.
The negative economic and market ramifications, however, have been somewhat offset by historic fiscal
and monetary policy responses.
We anticipate that both the economy and market may sustain a
welcome recovery in 2H 2020.
Several economic forecasts are calling for a 25% to 40% drop in Q2
U.S. GDP and U.S. unemployment could spike to 10-15%.
However, we believe both GDP and unemployment figures could
materially improve in Q3.
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efforts. In such a rebound scenario, employment is expected to recover as well, but
perhaps not as rapidly as GDP. While the expectation of some economic rebound
in Q3 is positive, the potential long-term economic damage as a result of the virus
shutdown is justifiably keeping investors nervous.
Our biggest concern for the economy may not be the short-term damage and
surprise of the shutdown. The unknown aftermath of the damage will likely take
time to unfold. Many direct customer-facing industries have been ordered closed
and industrial activity has been halted in numerous sectors. Supply chains have
been disrupted, detoured or cut off. Most consumer activity has been relegated
to purchases online or limited to grocery or other essential categories. Many
consumer and business incomes have been cut or pushed to zero. The effects
of containment may destroy many businesses, large and small, although new
government legislation has attempted to mitigate the worst case. Although
the government has incented businesses to retain employees, workers may
permanently lose jobs or be slow to return to work as the economy recovers. Due
to this unprecedented event, there is little visibility into when or how sharp the
recovery may be. As a result, risk assets may remain volatile.
Government Relief Programs
During the first quarter, Washington D.C. has certainly reacted quickly, repeatedly,
and with considerable force. Both monetary and fiscal programs instituted may
Quarterly Market Commentary Q1, 2020
The composite Purchasing Managers’ Index (PMI) is a measure
of manufacturing and services sector business activity.
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Quarterly Market Commentary Q1, 2020
have to clear some red tape before relief hits pocketbooks and balance sheets,
however policy support has indeed been more decisive than during 2008.
The Federal Reserve has re instituted 2008-era relief programs to support
markets and has operated at the fringes of its power to support both private and
public markets. The central bank has shown that it is not short of policy tools to
potentially affect the economy, even with its policy rate effectively at zero. The most
recent Fed action (announced on April 9) provides as much as $2.3 trillion in loans
to support small and mid-sized businesses, state and local governments, as well as
expanded support for large firms.
According to Bloomberg, the $2.3 trillion package is three times larger than the
total borrowed by the U.S. non-financial business and state and local government
sectors last year ($747 billion), and the package is more than a tenth of those
segments’ debt at the end of 2019 ($19.1 trillion). It is clear the Fed has aimed
considerable firepower at the problem.
Some of the lending/support facilities in which the Federal Reserve is now engaged
include:
• The Main Street New Loan Facility and the Main Street Expanded Loan
Facility—both programs combined will purchase as much as 95% of eligible
business loans from depository institutions. The depository institutions will
retain 5%. The combined size of the two facilities will be as much as $600
billion, backed by $75 billion of Treasury funds. Effectively, this allows the Fed
to buy loans off bank books allowing those banks to engage in additional
loan activity. Recall that current bank regulations place a limit on certain loan
activities relative to bank capital.
• The Paycheck Protection Program Lending Facility will supply liquidity to
participating financial institutions via term financing backed by Paycheck
Protection Program loans to small businesses. We believe this facility will
incent depository institutions to write Paycheck Protection Loans for small
businesses.
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Quarterly Market Commentary Q1, 2020
• The Municipal Lending Facility will purchase as much as $500 billion of short-
term notes directly from U.S. states and eligible counties and cities. The facility
is backed by $35 billion from the Treasury.
• The Primary and Secondary Market Corporate Credit Facilities and the Term
Asset-Backed Securities Loan Facility are backed by $85 billion from the U.S.
Treasury and scheduled to provide as much as $850 billion in direct primary
and secondary market purchase support for U.S. investment grade corporate
bonds, portions of the high-yield U.S. corporate bond market, commercial
mortgage-backed securities, and other asset-backed securities that fund a
wide range of lending including student loans, auto loans, and credit cards.
What is unique about the recent Fed action is the central bank is using a portion
of the CARES Act funding, left to the discretion of the U.S. Treasury, to effectively
collateralize its lending and financial market support activity. We do believe such
polices will have a dramatic effect on the U.S. economy and contribute heavily to
its stability and recovery. This bolsters the possibility of a Q3 rebound in economic
activity and the re ignition of sustained demand for risk-based assets.
Although the policy strategy is innovative and points to the power and re-solve of
the government to correct the problem, such an endeavor does further expose the
central bank to moral hazard criticism.
Coronavirus Aid, Relief, and Economic Security (CARES) Act
Recently enacted legislation provides relief for families and businesses impacted by
the coronavirus pandemic. The high level summary below highlights some of the
provisions that primarily are geared toward individuals and business owners. There
are many other provisions in this very comprehensive recovery legislation which are
beyond the scope of this publication.
These include loan programs for businesses, expanded unemployment insurance
benefits, new provisions on sick leave and family leave, and funding for a variety of
health-related efforts and government programs. Always be sure to work closely
with your own tax advisor for guidance in applying these new rules to your own
situation.
Federal Reserve policy certainly has certainly been
swift and bold...and we believe it will be effective in
lifting the economy.
Long-term, we believe the constant conciliatory bias of
Fed intervention is unhealthy for the sustainability of a
competitive economy and market.
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Quarterly Market Commentary Q1, 2020
Federal fiscal policymakers are debating other stimulus packages in addition to the
CARES Act.
For Individuals:
Stimulus payments
Payments of $1,200 (single/head of household) and $2,400 (joint filers) will be
sent to taxpayers within certain income limits. An additional $500 payment is
available for each qualifying child.
These payments will be determined based on your most recently filed tax return
or Social Security benefit statement, if no return was filed. The amount of the
payment is reduced by 5% of the amount by which income exceeds $75,000,
$112,500 (head of household), or $150,000 (joint).
IRA distributions
Required minimum distribution rules are waived for 2020 distributions from
IRAs, including inherited IRAs and 2019 distributions taken in 2020 which had a
required beginning date of April 1, 2020.
Distributions from IRAs received during 2020 of up to $100,000 for COVID-19
related purposes are allowed without a 10% penalty for pre-59 ½ distributions,
taxable evenly over 3 years beginning with year of distribution, and may be
recontributed within 3 years. Related purposes include a COVID-19 diagnosis for
you, your spouse or dependent, and financial hardship as a result of business
closures, reduced work hours, lay off, furlough, lack of child care or other factors
as determined by the Treasury Secretary.
Retirement plan distributions and loans
Required minimum distribution rules are waived for 2020 distributions from
certain defined contribution plans including 401(k), 403(b), 457(b) and IRA based
plans.
Distributions taken from qualified retirement plans received during 2020 of up
to $100,000 for COVID-19 related purposes are allowed without a 10% penalty,
taxable evenly over 3 years beginning with year of distribution, and may be
recontributed within 3 years. Related purposes include a COVID-19 diagnosis for
you, your spouse or dependent, and financial hardship as a result of business
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Quarterly Market Commentary Q1, 2020
closures, reduced work hours, lay off, furlough, lack of child care or other factors
as determined by the Treasury Secretary.
Qualified retirement plan loan provisions are broadened to allow loans up to
$100,000 or 100% of the participant’s vested account balance, whichever is less.
This applies to loans made within 180 days of enactment. Loan payments due
from the date of enactment of the CARES Act until 12/31/20 may be delayed.
Student loan payment deferral
Student loan payments and accrual of interest under certain federal loan
programs are suspended through September 30, 2020. Contact your loan
provider for information about your specific student loan.
Charitable contribution deduction
A charitable deduction of up to $300 is allowed for those who do not itemized
their deductions.
The adjusted gross income limitation is waived allowing you to offset more of
your taxable income.
These two items apply only to cash contributions and are not available for
contributions to donor advised funds or other supporting organizations.
For businesses:
Delayed payment of some employment taxes
Employers and self-employed individuals may defer payment of the employer
share of applicable Social Security taxes beginning on the date of enactment
through the remainder of 2020. The deferred amount may be paid over 2 years,
half in 2021 and half in 2022. These taxes are being deferred, not forgiven, so
businesses should be mindful about planning to pay these tax liabilities when
they eventually come due.
Expanded use of losses
Net operating losses (NOLs) from 2018, 2019, or 2020 may be carried back 5 years.
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Quarterly Market Commentary Q1, 2020
The 80% income limitation on use of NOLs is temporarily suspended.
The limitation on use of excess business losses is temporarily suspended.
Defined benefit plan funding requirements
Single employer defined benefit plans normally required to be funded in 2020
have their funding deadline extended to January 1, 2021. The delayed funding
will need to include interest accrued during the delay.
Charitable contribution deduction
The taxable income limitation for 2020 charitable contributions made by
corporations is increased to 25%, if the contributions are made in cash and
are not made to donor advised funds or other supporting organizations. The
limitation on contributions of food inventory is also increased to 25%.
Initial Considerations:
Accessing retirement plans
If you expect to access your retirement plan at work to meet unexpected cash
flow needs, it is very important to first talk with the plan administrator to fully
understand all of your options. It is equally important to talk with your tax
advisor to ensure you are eligible for these provisions and make appropriate
plans for paying taxes on withdrawals.
Charitable giving
Individuals who are in a position to make very generous charitable gifts can
get tax benefits that were previously unavailable. With this temporary relief
of income limitations on charitable gifts, these individuals may also want to
consider recognizing income since it could be fully offset by your charitable
gift. This may be a brief opportunity to consider a Roth IRA conversion or selling
highly appreciated securities in conjunction with your qualifying charitable gift.
Work closely with your tax advisor to do a detailed tax projection so that you
will be fully aware of how a particular planning strategy would impact your
overall tax return.
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Quarterly Market Commentary Q1, 2020
Amending business owner tax returns
The changes to NOL rules may provide an opportunity to amend previously filed
income tax returns to access refunds of tax paid in prior years. Work with your
tax advisor to determine your ability to access cash flow in this manner.
Many of these provisions contain limitations and other time sensitive or technical
requirements that must be considered in order to fully take advantage of them. The
next step is to connect with your advisors.
• Your tax advisor can help you understand how this legislation will impact your
federal and state tax situation. Your state may not follow these federal laws or
may put forth its own legislation.
• Your financial advisor can assess your overall financial picture and coordinate
your cash flow needs.
• Your plan administrator can discuss the changes to your retirement plan.
• Your local unemployment office is another resource to help you navigate
additional loss-of-pay provisions designed for those who have been unable to
work.
Wells Fargo Advisors is not a tax or legal advisor. While this information is not intended to replace your discussions with your tax advisor, it may help you to comprehend the tax implications of your investments and plan efficiently going forward.
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and nonbank affiliates of Wells Fargo & Company. © 2020 Wells Fargo Clearing Services, LLC. All rights reserved. CAR-0320-04765
Recovery Trajectory
As we study this volatile economic and market environment, and develop our
investment outlook, there are four primary areas of focus. We are hopeful the
positive progression of each could help shape the foundation for a sustained
recovery in markets, followed by an economic bounce back. The areas of focus are:
1. Lifting of virus containment measures by governments – The timing of and
economic return to normalcy in the U.S. is uncertain and will be heavily
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Quarterly Market Commentary Q1, 2020
debated in the coming weeks. Delays in restarting the economy and or a
decidedly slow restart could curtail expectations for an economic rebound
in Q3 and weigh on financial markets. In ourv iew, this is the biggest source
of uncertainty for the markets.
2. Normalcy in fixed-income markets - Helped in large part by Federal Reserve
policy, fixed income markets have begun to correct from the dramatic
spread-widening during this crisis. Fed support for both investment-grade
and high-yield corporate markets should offset some of the balance sheet
problems likely to be exposed by the economic shock. Such support has
materially helped equity markets and should set the stage for a sustained
recovery in stocks.
Wide yield spreads relative to Treasuries are a sign of
stressed pricing in bond markets.
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Quarterly Market Commentary Q1, 2020
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Important Disclosures:
The views expressed by the author are his own and do not necessarily reflect the opinion of Wells Fargo Advisors Financial Network or its affiliates. This and/or the accompanying statistical information was prepared by or obtained from sources that Wells Fargo Advisors Financial Network believes to be reliable, but its accuracy is not guaranteed. The report herein is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here reflect the judgment of the author as of the date of the report and are subject to change without notice. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request. All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value. The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The MSCI Emerging Markets Index is designed to represent the performance of large- and mid-cap securities in 24 Emerging Markets. Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market. The Bloomberg Barclays U.S. Intermediate Government/Credit Bond Index is the intermediate component of the Bloomberg Barclays U.S. Government/Credit Index which is generally representative of government and investment grade corporate debt securities.
3. Fiscal and monetary policy responses - As we have detailed in this report,
the policy responses have been extraordinary and there may be more to
come. They have helped stabilize markets and should have a positively
short-term influence the U.S. economy once restarted. The degree of relief/
stimulus aids our constructive outlook for a Q2 recovery in risk-based asset
prices and a Q3 recovery for the economy.
Oxford Harriman & Company