MARKET COMMENTARY

Top 10 Questions from Clients Answered

04.10.2020 - Carin L. Pai, CFA

Top 10 Questions from Clients Answered

Q. Is the US headed for a recession?
We expect the US to fall into a recession, at least a technical recession as defined by two quarters of negative growth. The depth and duration of the recession are uncertain at this point as a good deal is dependent on when and how well the coronavirus is contained. Our base case is that the US will eventually “flatten the curve” and we expect the economy and the markets to experience a recovery as we look one year ahead.

Q. What permanent secular changes do you see in the economy?
The world will probably look different on the other side of the coronavirus epidemic. We expect the trend toward digitization of content to be magnified for consumers (i.e., online media, games) as well as businesses (i.e., document sharing). With many businesses adapting well to working remotely, this may lead to a reduction in the commercial office market as well as corporate travel. E-commerce and logistics growth will accelerate at an even faster rate in our view.

While discussions around supply chain changes began during the trade war between the US and China, the pandemic will likely cause these shifts to accelerate. For example, the healthcare sector will likely produce more personal protection equipment and compounds for drugs. Additionally, we believe businesses will need to re-orient their value-add propositions and focus more on health safety than ever (i.e., airlines).

That being said, we think it is unlikely there will be long-lasting effects from the pandemic on broader economic trends. We believe slow to moderate global growth will eventually return, although we could see a temporary spike in consumption by way of pent-up demand following the lockdown period.

Q. Has the market bottomed out yet?
The market has started to move from a period of extreme anxiety and uncertainty to one with continued uncertainty but with some clues. We expect a bottoming-out process to occur as more clarity unfolds around the virus containment efforts and the accompanying setback to the economy. We anticipate continued volatility and a challenging investment environment to persist for the next few months.

Q. Should I adjust my asset allocation in this environment?
Strategic long-term asset allocation strategies should not be changed in this environment unless your financial circumstances have materially changed, i.e., loss of salary or a life-changing event such as death of a family member or divorce. These types of events would usually trigger a reassessment of your long-term goals and cash flow needs. Time horizon is very important, and if it has changed your asset allocation may need to shift.

We think that markets will be at higher levels a year from now and would generally advise staying the course and not selling into volatile markets. With a long time horizon, it makes sense to use the next couple of months to invest opportunistically as well as to revisit your individual financial goals.

Q. I rely on my investments for living expenses. Should I ratchet down my spending to avoid tapping into principal?
For most people, the amount they withdraw from their portfolio is made up of a combination of income (dividends and interest), appreciation, and in some cases, tapping into principal. In today’s environment where interest rates on fixed income investments have dropped, and dividends from stocks are likely to be reduced as companies attempt to preserve cash in order to weather the current economic downturn, it’s likely many investors will be tapping into principal when they previously were able to rely only on income and appreciation, or possibly even just income.

If you’re in that situation, your focus in determining an appropriate spending rate should be on running a comprehensive financial plan. Ultimately, whether or not you need to tap into principal depends on your goals and others factors, such as the type of investments you own, the size of your portfolio, your spending needs and the market environment.

A financial plan can determine what is a sustainable level of spending given your goals and tying in an appropriate long-term asset allocation. It is important to run your financial plan in any case, but if your spending rate is over 3% a year of current values, you should definitely take the time to determine if that is sustainable. We can help you stress-test different levels of spending through lifetime financial projections. We can also consider potential market ups and downs and variations in other assumptions relevant to your circumstances. This can help you make sound decisions about your spending and provide you with peace of mind that short-term market volatility will not derail your long-term goals.

Q. Where are you finding opportunities within fixed income markets?
We think it is important in the current environment to differentiate between the various sectors of the fixed income market. While it is true that the fed funds rate and the front end of the yield curve are near 0%, other areas within fixed income, however, can represent opportunities, especially in the wake of recent Federal Reserve support for credit markets. In particular, the Federal Reserve has committed to support various sectors that still trade at attractive yields relative to US Treasuries. The recent flight to quality has made cash and US Treasuries fully valued along with Agency Mortgage-Backed Securities which briefly traded at attractive levels before tightening in the wake of the announced Federal Reserve purchases.

More credit-sensitive parts of the market—investment grade corporates, high yield, and municipals in which the Fed has made a commitment to provide support—represent opportunities in our view. Given the slowdown in economic activity, credit deterioration will evolve in both taxable and tax-exempt markets, but we continue to find high-quality securities that have become attractive as a result of the broader market dislocation.

Q. Where are you finding opportunities within equity markets?
Given the expected decline in economic growth and a low interest rate environment, we maintain a favorable view on Consumer Staples. Similarly, Utilities provide a large degree of countercyclicality, displaying defensive characteristics based on their relative attractiveness from a yield perspective.

We believe there are opportunities within the ‘digital transformation of content’ trend underway within Communication Services, which is allowing consumers to engage and share information in a new paradigm. Likewise, we find Information Technology to be attractive, especially in a post-virus world in which the benefits of connectivity and digitalization become ever more critical.

And, our long-term outlook remains positive on Healthcare because of US demographics and an aging population, the unmet medical needs in oncology, diabetes, hepatitis B and Alzheimer’s, to name a few, and innovative treatments starting to emerge, specifically in genomic therapy.

Q. Are companies with high ESG scores better prepared to handle this crisis than other companies?
We have found that companies with high ESG scores, meaning those firms that have been highly rated across a variety of environmental, social and governance factors and have made substantial sustainability efforts, tend to be higher-quality companies.

In an uncertain environment such as today, the market often rewards higher-quality companies and, therefore, those with high ESG scores have been outperforming compared to their lower-score peers. However, in this crisis, performance has been industry specific. For instance, companies in the travel, hotel, restaurant areas have suffered over the last month, regardless of their ESG scores.

Q. Should I consider entering the market now?
The answer to this question involves a mix of financial planning, long-term strategic planning and tactical investing. First, you should ensure you have enough cash set aside for the immediate future including any short-term goals such as a home purchase, gifting or private investments.

Also, you should have a firm understanding of your tax picture. For example, if your excess cash was the result of a sale of stock, property or even a business, taxes will be a significant factor. The CARES Act now allows charitable contributions up to 100% of an individual’s adjusted gross income for 2020, which may make charitable giving a more attractive strategy to help mitigate any tax liabilities.

If you have determined that you have enough cash to meet your needs, deploying cash into the market may make sense. Your investment strategy for spare cash should be determined by your long-term asset allocation targets, with a tactical lens driven by the current environment. In this volatile and uncertain market environment, we recommend a more defensive investing approach and a focus on companies with strong balance sheets and historically healthy earnings growth in sectors such as Consumer Staples, Healthcare and Communication Services.

We also recommend dollar-cost-averaging (i.e., making multiple investments over time vs. one lump-sum investment) over the next several months. It can be tempting to try to time a market bottom, but as we continue to deal with high volatility and uncertainty, timeframes to implement baseline purchases generally have been extended. Your portfolio manager can help determine the optimal increments and implementation timeframes based on your specific situation.

Q. With Required Minimum Distributions (RMDs) suspended for 2020, should I forgo these distributions?
We think the best way to think about forgoing distributions such as RMDs is as additional savings, i.e., if you don’t make a withdrawal, you build up savings. Not only will you avoid the tax impact of the withdrawal, but the funds can remain invested in your account. In a depressed market, staying invested can have an extra impact as your investments participate in a recovery.

However, it’s also important to balance the sacrifice involved in the savings with your regular cash-flows and long-term asset allocation. Short-term savings may be helpful, but the biggest impact comes from shifts made to your withdrawal rate over the long term and how calibrated your asset allocation mix is to meet your financial goals.




The information provided is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact regarding any market, industry, sector or security. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy, or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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