Passed Pawn Advisors February 2020
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Passed Pawn Advisors

A next generation digital investment advice firm utilizing the latest methodology and technology to create sensible and affordable financial solutions for our clients

Quote Of The Month

Yesterday all my troubles seemed so far away.  Now it looks as though they're here to stay.”

-- Paul McCartney

Economic Highlights

  • The COVID-19 Coronavirus outbreak is now officially a pandemic, affecting everyday activities and economies globally

  • The Fed announced an emergency 50% rate cut between meetings, plus additional bond buying program, while an additional big cut is expected widely next week

  • US and foreign governments are considering and implementing various containment policies and economic stimuli

  • US payrolls remain robust, and other lagging indicators look fine, but the full economic impact of the virus is unknowable at this time

  • Saudi Arabia and Russia break away from OPEC+ to start an oil price war

Market Highlights

  • US Equities had a volatile month – 3 weeks up and 1 week WAY down, with S&P 500 Index closing lower by -8.2%

  • Most major foreign equities dropped, with Developed Markets leading lower by -9.0%

  • US high-grade bonds added 1.8%, on flight to safety. US inflation-linked bonds were the other safe asset class, up 1.4%

  • US REITs were also dropped -7.9%

  • Commodities tumbled another -5.0%, led by oil’s -12.3% drop, while gold finished -0.2%

Observations and Expectations

Last month, we discussed the concept of a black swan – an unpredictable event that comes out of the blue, with unknown global risks that could reach doomsday scenario – and how the Coronavirus had a chance of becoming one. Just three short weeks ago, which feels like eternity, the US equity markets hit an all-time high. Investors continued at that point to hope that the virus spread will follow the scenarios of SARS, Zika, Ebola, and many others that were another continent’s problem, and that it would also never truly impact the US.

Boy, do we live in a different world today than we did just three short weeks ago.  As the spread of the virus went truly global, the fast-moving nightmare scenarios started to unfold.  With deaths in thousands and cases over 100,000 globally, the virus poses a real health threat, having spread to about 100 countries in a very short period of time.  While its mortality rate is still relatively low, its long incubation period that makes its spread difficult to trace has created a chain of events with serious economic consequences.  Since the best prevention of the spread is believed to be social distancing, the governments around the world and in the US have moved to use emergency measures to limit mobility and large crowds, severely disrupting the normal travel and everyday activities.  The closures of schools and universities, cancellations of conferences, sports and entertainment events (including unprecedented suspensions of NBA and NHL seasons and cancellation of NCAA March Madness), and severe travel restrictions are causing major disruptions all over the economy, beyond the supply chain issues.  Small businesses relying on people going to work, getting around on their commute, going out for lunch and dinner, and doing their other daily chores have no obvious substitute for their regular income.  Parents are struggling with many kids unable to attend schools, and many spring break vacation plans have been ruined, without a good substitute.

The US equity markets in the meantime have responded with some of the most ferocious selling ever, having logged 20%+ loss in three weeks, despite four up days – which are now the four largest point gains in history.  The volatility and the sheer speed of descent is quite unprecedented; 1929 and 2008 pale by comparison.  The situation remains very fluid, and the future is unknowable, yet investors undoubtedly find themselves facing a real dilemma: what now?  On one hand, such a steep selloff may provide a good buying opportunity if our worst fears don’t materialize.  On the other, if the risks are real and effects on the economy prolonged, perhaps it’s not too late to cut losses and get out.  If you’re wrong in the first case, you put more money at risk.  If you’re wrong in the second, the tax consequences, wash sale rule and lost opportunity to recover would also put a big dent in your savings.

While no one can know for sure, I can attempt to rationalize the situation.  Being of a quantitative mind and training, I formulate scenarios and try to assign probabilities to them.  Then I have "red-lines" or triggers to tell me when scenarios might go from bad to worse.  The following is the result of this exercise:

  • Scenario 1: Strict measures reduce the spread of the virus in the next 4-8 weeks or so (following the pattern in China), and economic activity returns, helped by global government stimulus.  The dip in corporate earnings lasts 1-2 quarters.  The market recovers relatively quickly and is already oversold.

  • Scenario 2: The virus spread gets worse causing major economic disruptions for months.  Mild recession occurs for 2-3 quarters and the economy recovers with additional stimulus.  The market drops 10-25% more and takes 1-2 years to recover.

  • Scenario 3: The health situation gets much worse (i.e., the spread of the disease happens faster, the virus gets worse through mutation, longer incubation period or drug resistance, etc.) and causes the entire economy to near-halt.  Deep recession follows for the next 1-3 years.  The market drops another 20-50% and takes 3-5 years to recover.

The probabilities I would assign to these scenarios based on what we know so far are: 60% / 30% / 10%.  While clearly debatable, I consider these conservative, and I certainly hope that the apocalypse has less than a 10% chance.  The real life will also probably be only partially following these assumptions, but I feel that it’s a good approximation.  Given this analysis and a 5+ year investment time horizon, it still makes sense to stay in the market, but some adjustments may still be needed.  My red-line for the worst-case scenario would be when the US government put an entire major urban area under quarantine Italian-style and/or ban domestic air travel.  That would signal things are far from over and perhaps it's best to sit it out.


Also, one more note on the hedges.  We’re reprinting the Question of the Month from February, which is still a valid discussion.  However, some things have already changed.  By design, every hedge could work against a certain market risk or perhaps several of them, but not all.  Based on our proprietary research, we developed a matrix of market risks and hedges that shows what works best for specific risks, on a scale of 1 to 10, with 10 being the best hedge.  The black swans are unknown events that are notoriously hard to hedge against, and even when you plan for them the hedges sometimes don't act as expected in a panic. For example, gold traditionally works well as a hedge against falling equities, but there was a huge selloff in gold last week together with equities because apparently people were cashing in to cover margin calls.  Real estate is split, with retail and commercial properties suffering.  Treasuries, on the other hand, acted as expected, but already look tapped out at the lowest yields ever, and may no longer offer a good hedge going forward.

Other Risks:

Finally, a quick word on the other market risks looming in the background.

  1. The 2020 election risk has been somewhat mitigated to the market’s satisfaction with Biden’s surprising lead in the wake of Super Tuesday results.  The market will continue to react negatively should Sanders gain ground again.

  2. Saudi Arabia and Russia chose an opportune time to break the OPEC+ multi-decade tradition to follow cartel rules and unleashed an all-out price war.  With oil prices being already hugely depressed, they bet that the US shale oil companies as well as some of the more expensive country producers will be forced out of the business.  The traditional energy sector has already been absolutely crashed, but the vastly lower oil prices are helping the consumer.  The other unfortunate loser here is the alternative energy, which is now less competitive in the face of cheap oil.

  3. While the world is dealing with pandemic, other geopolitical risks are lurking the background.  Russia effectively witnessed a coup, with the entire government removed overnight and the Constitution updated to allow Putin to rule indefinitely.  North Korea is back to launching ballistic missiles.  Russia and Turkey are conducting military actions in Syria.  Does anyone think that Iran has forgotten the January escalation with the US?  And the Brexit, contrary to the popular opinion, is not yet over, as the next steps may get postponed or worse in the face of current economic issues.

Sector Update

Industrials sector is the Bear of the Month, just because we’re tired of making Energy sector, down 45% in 10 weeks, the scapegoat.  In addition to a big chunk of this sector being in Transportation and Airlines, decimated in the wake of the virus threat, the supply chain disruptions are hurting manufacturing all over the world.  And we suspect that in the post-Coronavirus world some of those supply chains will be at least reconsidered.

Consumer Staples are the bear market darlings.  That’s because the companies that make up this sector make goods and provide services that have inelastic demand – another words, that are needed no matter what happens with the rest of the world.  Household cleaning items king, Clorox (CLX), is just one example.  To grasp its full meaning all you need to do is look at the empty shelves of a local Costco (COST) store where the toilet paper and canned Campbell Soup (CPB) used to be.

Market Data

Want to see a market snapshot and all your favorite stocks in one place? Try our market data pages.

Question of the Month

This is where we answer the best investment question we’ve heard all month. If you’d like your question to be considered, please send it to us.


How can the Wuhan Coronavirus affect my portfolio and what should I do about it? [A reprint from last month]


This question, in one form or another, has been on the mind of most investors.  And if our portfolio is heavy on equities, the likely short answer was, negatively.  The full picture is a bit more nuanced, of course.

First, let’s look at parts of the market that are negatively affected:

  • China.  Duh! The economic fallout is greatest at the epicenter, and may have a lasting effect.  Close neighbors and trading partners, and general Emerging Markets investment vehicles in equities and fixed income also suffered.

  • Hospitality industry.  Hotels, casinos (Macau has been a focus for majors for the last two decades), airlines, and cruise lines are all severely affected.  The last group may be the most profoundly affected with seemingly daily headline risk.  Local movie theaters, restaurants, and brick-and-mortar retailers will also be affected, but there are fewer foreign companies in these industries.

  • Major global exporters.  Virtually every multinational corporation has made China and its large and fast-growing economy their target this century.  Consumer products and industrials will feel the most pressure.

  • Global companies that China supplies.  This could be an extensive list, including but not limited to, technology, industrials, and consumer goods.

  • Energy and materials.  These two are the ultimate cyclical sectors, and they suffer greatly from a sudden drop in economic activity and therefore lower demand.

Now, on the flip side, some areas are getting a boost:

  • Infectious diseases biotech.  Many companies within this group have the know-how to jump into the Coronavirus R&D and may have.  A cure would be an ultimate prize, and investors have taken notice. One of our focus stocks has been Moderna (MRNA) and it belongs to this group.

  • Household and medical product stocks.  The need for basic cleaning and prevention supplies drives up the demand.

  • Utilities and Real Estate.  Domestically-focused, stable and steady sectors are the perfect safe harbor in the eye of the storm.

  • Small-caps.  These companies with largely domestic markets attract investors in times like these, especially in services and technology.

  • Treasuries and municipal bonds.  Again, the theme is safety and no global exposure.

Finally, the question is what to do next. That, of course, depends on the future development of the epidemic.  Unfortunately, there’s little we can use to draw definitive conclusions.  The Wuhan Coronavirus was compared to the two largest viral outbreaks earlier this century, SARS and Ebola.  Ebola was originated in Africa, and while the number of cases skyrocketed initially, the virus was largely contained to that continent and eventually had little global economic effect.  SARS did also originate in China and bore some resemblance to the current situation.  However, the Wuhan Coronavirus already surpassed the death toll of SARS and is threatening more human devastation.  Also, China’s share of the world GDP more than tripled since SARS, and today’s global economy suffers quite a bit more due to the Chinese supply chains.  Even beyond physical goods, Google, Microsoft and Amazon had to temporarily close down their offices in China.

Most analysts and observers expect the so-called COVID-2019 or the novel Coronavirus to be contained soon enough, and the economic impact to be limited and short-lived.  If that holds true, many beaten down travel and consumer names may be a bargain.  But a true black swan can’t be easily predicted.  If the experts are wrong, the potential risks could much outweigh the upside.  We’d recommend US real estate, utilities and US high-grade fixed income, with select technology and biotech, until the fight with the Wuhan Coronavirus enters the decisive stage.

ETF Education

We have recently added a new section to our website designed to provide educational, reference, and news resources to investors in the growing world of ETFs. Product knowledge, understanding cost and tax structure and how ETF trade works can help investors of all stripes find better opportunities for their portfolios and improve its risk management. Knowing the mechanics of volatility ETFs, for example, could have helped $XIV ETF holders avoid huge losses last week.

Featured Motifs

Motif Investing is an innovative broker that allows you to treat a portfolio of equities as a single unit.  We utilize their platform to offer our clients affordable solutions in thematic investing.

Each month we highlight 3 of our motifs that play on current market themes.

Motif The Gold Retrievers
Risk Profile Conservative
Time Horizon Short/Mid-Term

This motif focuses on major pure-play gold miners listed in US.  The stocks were screened for only positive projected EPS growth next year.

Motif Come Together
Risk Profile Aggressive
Time Horizon Mid/Long-Term

As the world becomes more digital by the day, it seems, so does the way people communicate and work together.  These companies benefit from this trend by providing tools for messaging, conferencing and collaborating.

Motif The Sum of All Fears
Risk Profile Conservative
Time Horizon Short/Mid-Term

When equity markets take a sharp downturn, equity portfolios typically suffer.  This "Black Swan" portfolio is designed to withstand just such periods and includes defensive and hedged equity, fixed income, hard assets, etc.

Ignore at your own risk.

Investing Hot Reads

Model Portfolio

See how our proprietary algorithm creates a customized portfolio just for you

Our Papers

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In The News

  EquityMag: Case Study
The materials presented above serve informational purpose only and do not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. The author, Passed Pawn Advisors, LLC, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment assets mentioned above. Motif Investing portfolios that may be presented are created by Passed Pawn Advisors, LLC, and are available for purchase through their site.
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