Bourgeon Capital's Market Update
Published March 10, 2020
What is Causing the Recent Stock Market Volatility?
It has been a long night after a long day. We have been visited by the grey rhino (a highly probable, high impact yet neglected threat), or perhaps two or three of them.
Over the weekend (3/7/2020-3/8/2020), in a surprise move, Russia declared that it no longer wanted to help Saudi Arabia keep production in line with demand to maintain oil prices. In response, Saudi Arabia cut oil prices by 30% as a means of gaining market share over Russia. Nobody likes surprises, especially the financial markets, and on Monday the financial markets were in disarray, closing down 7.6%, the worse one-day drop since 2008. This geopolitical disarray comes on top of the human and economic toll coming from the coronavirus, leading many to assume that the likelihood of a recession increased. Governments and financial institutions around the world are working on responses – either lowering interest rates, boosting liquidity, or implementing targeting financial support to the industries most in need. We are seeing a strong rebound in stocks this morning (3/10/2020). It is how the events resolve over time that will dictate how long this stock market volatility will last. We are using this volatility to our advantage while trying to be methodical and thoughtful in our approach both to buys and our sells. We continue to focus on the long term but also with a certain amount of caution and safety.
We have been asked, is this like 2008? We don’t think so. 2008 was a financial shock that affected the demand side of the economy, leading to a financial, balance sheet recession. In our opinion, today we don’t have a highly leveraged banking system with limited capital controls, and we don’t have the vulnerability in the banking and financial system which led to severe distress in the Great Recession. High debt levels are more concentrated in governments as opposed to banks and/or consumers. That being said, low oil prices could lead to difficult times in states such as Texas and North Dakota. This may be partially offset by the economic boost of low oil prices on consumer demand.
We continue to believe that the virus will cause an economic downturn, but that it will be relatively short-term in nature, perhaps two quarters or so. We look to China and South Korea as an example. For China, their initial virus crisis lasted only a few months. Recent economic numbers have been abysmal. But the Chinese economy is slowly picking up and recovering. The rest of the world is a few months behind China. South Korea might be a better proxy for us as an open economy, and we are hopeful that we have seen the peak of infection rates there. We expect that in the US it may continue to worsen now, but that we will recover as well. Markets will continue to react with the daily virus news flow in the short term. Our focus will continue to be the virus growth rates. As the growth rate peaks, stock market volatility and weakness should subside as well.
Our recovery will be aided by both fiscal and monetary stimulus. Already the Federal Reserve has lowered interest rates by 50 basis points. In addition, they are working on solutions to keep the credit markets working smoothly. We expect they will do more. Already the government has approved an $8 billion virus aid spending package. We expect the government will do more as well, such as loan programs, regulation holidays, and other targeted fiscal spending programs that will support the economy.
After the virus has moved through the world, what will remain is the stimulus in the system. With historically low interest rates, economic growth should improve, and corporate earnings should recover. From a valuation perspective, we started 2020 saying that valuation was high with stocks selling at 19x earnings. Valuations today are at 17x earnings (although the earnings numbers are a bit suspect). However, with interest rates now as low as they are, valuation multiples should increase. The 10-year yield is now under 1%. Dividend yields on stocks are now 2.5-3.0%, with some as high as 8% on quality stocks. As we said above, and would like to reiterate, we are trying to be more methodical and thoughtful in our approach both to buys and our sells. We continue to focus on the long term but also with a certain amount of caution and safety.
We hope all of you are safe and remain healthy. We understand that times like these can be unnerving. Our goal, as well as our mission, is to protect your capital long-term with good risk adjusted returns. We feel confident that we can deliver on that goal for you. We look forward to speaking with you soon and thank you for entrusting us with the management of your money.
John A. Zaro III
Laura K. Drynan
This letter should not be relied upon as investment advice. Any mention of particular stocks or companies does not constitute and should not be considered an investment recommendation by Bourgeon Capital Management, LLC. Any forward-looking statement is inherently uncertain. Due to changing market conditions and other factors, the content in this letter may no longer reflect our current opinions. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this letter will be profitable or suitable for your individual portfolio. In addition, past performance is no indication of future results. Please contact us if you have any questions regarding the applicability of any matter discussed in this letter to your individual situation. Please contact us if your financial situation or investment objectives change or if you wish to impose new restrictions or modify existing restrictions on your accounts. Our current firm brochure and brochure supplement is available on the website maintained by the Securities and Exchange Commission or from us upon request. You should be receiving, at least quarterly, statements from your account custodian or custodians showing transactions in your accounts. We urge you to compare your custodial statements with any reports that you receive from us.
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