Mar 23, 2020
Meritage Current Market Update
In the past week, we have seen unprecedented, disruptive events occurring at speeds that stretch anyone’s comprehension. As these developments unfold, the markets are extrapolating this new information each day into longer-term outcomes, each more dire than the last. When fear is driving this reaction, the orderliness of the process breaks down and day-to-day pricing becomes unhinged. Below is a chart of the past eight trading days, not including Friday’s 4.5% decline.
As all of us are painfully aware, the exponential growth rate of COVID-19 infections around the world (and particularly in the U.S.) has moved us to an unthinkable shuttering of our economy for an undetermined period of time. Whether this was something that was inevitable three weeks ago or not, it seems that most of us have arrived at this reality all too suddenly. In similar fashion, the markets left us in the midst of a full blown bear market with all the requisite concerns of how much worse could it get. While this is a necessary component of moving toward an ultimate bottom, the timing of that is highly uncertain for now.
While we have mentioned this before, it is also important to understand that daily trading patterns that seem wildly out of control are greatly influenced by computer driven, automated, short term trading mechanisms. These tools are triggering unprecedented daily swings in even the largest and strongest companies, many in the range of 10%-20% and sometimes in both directions. For smaller, less liquid companies, the volatility has generally been worse. This extreme volatility makes it incredibly challenging to apply basic investment principles without accepting the continued erosion of risk capital on a near-term basis.
All of the discussion points in our earlier memos continue to be operative. The unprecedented risks in front of us have been alarming, but the escalating social and economic uncertainties that have come to fore in the past week confirm some of our deepest concerns. As such, we are more inclined to add to the growing cash levels inside each of our equity strategies to provide additional cushion should the news flow continue to deteriorate.
For now, we would envision cash levels expanding to approximately 20 – 25% from current levels. Both our Growth and Value Equity strategies have already begun moving in this direction. To put in perspective, a portfolio with a 60% equity target and allocated across our three equity strategies (and accounting for existing cash) would see overall cash levels increase by approximately 5% to 7%. All strategies have made preparations to implement this additional layer of safety promptly. For now, cash will reside in the higher quality money market funds available from our custodial partners.
Markets already know today that infection growth rates won’t crest for many weeks, our treatment facilities and supplies are insufficient, and unemployment levels will soar. Much of these grim expectations may already be embedded in today’s stock prices. What is not priced in is the unknowable – the duration of the economic contraction and the implication of that on what an inevitable recovery might look like. The prospect of jumpstarting an economy and workforce from a virtual stop now seems the most daunting challenge. While we expect periodic rallies to crop up like we’ve seen, we believe this recovery risk is destined to overhang the market until we get further along the process.
On the positive side, our policy makers all the way down to the local level now speak in unison about the need for bold, aggressive action to help businesses of all sizes and relief for workers to survive this economic chill. We also recognize the aggressive action taken by the Fed last week to protect the liquidity of the credit markets, which is necessary to maintain confidence in the market system, notwithstanding all the volatility.
On an administrative note, today is the last day we will be working directly from our offices as we enter a 30 day “stay at home” order for our region. Our Business Continuity Plan (BCP) is fully in effect and we expect business will be conducted as usual. For now, our phones will be answered with an automated attendant that will assist you in reaching the appropriate person via our call forwarding functions.
We will be back in touch with further updates. We look forward to those updates eventually including thoughts on the need to reduce cash levels. Until then, we wish everyone and their families good health.