The Dividend Cafe - National Conference Call Replay - Covid 19 and Market Lows

Episode Date: March 17, 2020

Join TBG Chief Investment Officer for a National Conference Call where he delves deep into the reasoning behind the massive moves in the markets over the last three weeks. Share it with your friends! Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Please feel free to send your own questions to us even now at rsvp at thebonsongroup.com. But in the meantime, enjoy this replay of our national conference call addressing all elements of this coronavirus epidemic, its impact on markets, and what our overview and viewpoint and perspective is as we navigate through these very difficult times and look into the future. Thank you for listening to this special Dividend Cafe National Conference Call Replay. Well, good morning to those of you on the West Coast and good early afternoon to those of you on the East Coast. And I hope you will find this call today to be useful in these crazy times in which we are living. There is nothing I can think of that I would like more than to be able to address clients and friends around the country in a different setting, in a different context than the one in which we find ourselves, which has truly not only

shocked capital markets, but shocked the country and, of course, many other countries around the world. I will start, and it isn't token, and it isn't cliche. It is absolutely the priorities of my heart and of my team and of humanity that the health epidemic is our number one concern. Those who are sick, those who are frail, those who are vulnerable, we lift them up in our thoughts and prayers. There are 190,000 diagnoses of COVID-19, this particular strain of the coronavirus that has spread out of the Wuhan area of China since late last year, early this year. 190,000 diagnoses worldwide that has so far resulted in 7,500 fatalities worldwide and 81,000 recoveries with 102,000 active cases. In the United States, there are 5,696, so let's call it 5,700 diagnoses resulted in 97 deaths so far, 74 full recoveries with 5,500 active cases. But of course, those numbers are really the subject of all the current distress because they're believed to be very

underreported based on limited testing that has been done. And I'll speak to that medical aspect in a short while. So the reason for having an economic and capital markets conversation about this health epidemic is, of course, this utterly violent and unprecedented impact into markets that has just hit everybody upside the head over the last several weeks. Three weeks ago, the market began its severe distress, dropping 4,000 points in a week with virtually no up days, up rallies, etc., just a sort of straight down movement. And then the next week went up violently, then down violently each day, resulting in a week that was actually, and this feels to me like it was 10 years ago. It was two weeks ago.

The market was actually up a few hundred points on that week. And then we entered last week, the one I believe many will never forget, certainly in my profession and many investors personally, as the market crashed on Tuesday, rallied a bit, pretty significantly Tuesday, gave that back Wednesday, and then had its worst day on Thursday since Black Monday of 1987, its worst day on Thursday since Black Monday of 1987, but then did rally back 2,000 points on Friday, still nonetheless a net-net of down 2,000 on the week. And then yesterday, the worst day in market history on a point basis, and the second worst day on a percentage basis in market history, down 3,000. As I sit here right now, the Dow is up about 550 points. It has been down 300. It has been up 1,000. I would read nothing into what is going on on a minute-by-minute basis, and that's going to be a major subject of the call today.

And that's going to be a major subject of the call today, the violent movements intraday, intrahour, intraminute, and why they are so indeed undetectable and unreliable and unhelpful in the present insanity. So the purpose of our call today is going to be assessed where we go from here, what our various expectations are. That's a big picture. That's high level. It's macro. And then the second element is what we specifically do from here, not just where the economy goes or the market goes, where the country goes, but then what we do from here has to do with our portfolio thinking and best answers.

I've received a ton of questions in advance of the call, and I intend to be able to address all of them that I don't think I already addressed through the ebb and flow of my basic outline. And so some of you may choose to drop off the call near the end. I will just continue to go until I can get through as many of the questions as possible. And in the meantime, if you have a question, feel free to send it during the course of the talk to RSVP at thebonsongroup.com. It is very possible we will not be able to get to those questions that come up in the middle of the call, although we're going to try. But we may have to just provide an answer after the fact and incorporate it into our written communique this afternoon. So what I said a moment ago about the current phase in the markets is very important for those of you who want to understand kind of what's going on behind the scenes in global markets.

I think everybody is aware of the obvious stress that the virus and that the fear of the virus has in a direct level to the economy. A country seemingly on near lockdown, the total and complete freeze up of travel, of entertainment, of dining, of hospitality, of consumer spending. It is not difficult to understand why those things would lead to catastrophic results in the market and in the economy. And then there is a big debate as to how lasting some of those things will be and what the recovery ends up looking like. of those things will be and what the recovery ends up looking like. But speaking right now, not yet to the macroeconomic impact of this virus, but to the particular market effects that we've been living through, not the whole three weeks of this distress, but particularly the last week.

This is something that I believe is important for investors to understand in this drama, in this distress, and in all severe distresses. And that is the reality of life in a leveraged financial system. That so much of what is taking place right now is a byproduct of forced selling because of the significant amount of financial actors that have assets, that have positions, that are bought with some degree of borrowed money so that when there is a distressed event that leads to selling, it catapults into more selling. But nobody wants to sell the asset that is distressed when they need to sell,

so they turn to other assets that are not distressed, creating a correlation of one. Everything ends up correlating together, not because a treasury bond is actually distressed, not because a AA municipal bond is actually distressed, not because a AA municipal bond is actually distressed, not because a money good investment grade corporate bond is distressed, but because that's the only thing they can sell. So that this, what's the word, asymmetrical amount of selling relative to organic buyers creates downward pressure on even good assets. This is what has messed up the world financial system for the last week, and it has happened in each period of severe distress ever in the history of capital markets, but particularly in the kind of adult era of capital

markets that has been the last 40 years. Throughout my lifetime, now first my lifetime as a professional investment advisor, post 9-11, post financial crisis, to a more limited degree through some of the European sagas of the last 10 years, and then now what we're living through now, this has always been the effect. Sometimes the spillover distress into other elements lasts a week. Sometimes it can last a month. The financial crisis is really the only time it lasted much longer, but that was because of the severe amount of distress that existed in so many asset classes. So as I'm about to talk about in a moment regarding the Fed and the

unbelievable role that they are stepping up to play right now, this is really entirely what is going on. I have spoken for years now about the leverage that is built up in the financial system, not on the balance sheet of banks, which are all across the board significantly less levered than they were in the financial crisis, which all have significantly improved capital ratios, which all are in dramatically different positions relative to that godforsaken period of late 2008. What I'm referring to is the corporate economy at large, that the Fed has begged. First of all, the country begged the banks to delever post-financial crisis for obvious reasons. They did so. And then the country begged the private sector to relever, and they did so. So there's a significant amount of leverage in the corporate economy, more credit,

corporate leverage in the corporate economy, more credit, and therefore putting the Fed in the position where where there are good assets, money, good assets that are just in this period of distress because of selling pressure, the Fed is having to be the lender of last resort in providing that liquidity off of that collateral to keep the financial system functioning. So in the meantime, the problems become compounded. If you boil it down to an individual investor, which is not necessarily one who's going to be moving the entire market, but is kind of struggling through the exact same dynamic of much larger investors. Now, what I refer to is the element of for-selling. It's just that for-selling from a multi-billion dollar risk parity hedge fund

can be a massive issue. For-selling from an individual investor doesn't necessarily have a macro impact, but it certainly affects that investor when they're getting bad bids trying to sell some municipal bonds. Or let's say bad bids trying to sell some municipal bonds. Or let's say they're not trying to sell any municipal bonds, but someone down the street is. So that bond is getting a bad mark because of all the forced selling, and then it reflects on that client's statement as if the bond is down two or three points when, in fact, its fair value is completely unimpeded.

So we're seeing that across the board. How do you know when this is the dynamic at play, these technical challenges? Well, for one thing, let me point out to you the utter worthlessness of safety over the last couple of weeks. Utilities as a sector are down the same as the S&P 500. REITs are down more than the S&P 500. This long-discussed notion of gold as a safe haven is down from $1,700 an ounce to $1,475 an ounce.

So there has been no real place to hide. This is an incredibly rare occasion when correlations go to one because of the leverage in the financial system. It plays itself out. All of the panic selling, excess selling, forced selling, margin selling eventually runs its course. And it's one of the panic selling, excess selling, forced selling, margin selling eventually runs its course. And it's one of the reasons it's an incredibly bad time for people who don't have to sell to be selling because they're selling into a downward avalanche. Now, this is not the same as saying that once this forced selling is done, everything immediately goes back up to normal. Everything goes back to a normal state of affairs and the normal state of affairs is not going to be very good. And I'm going to talk about that in a moment. However, the normal state of

affairs significantly below the high levels markets had been at a month or two ago is still much higher than where it would be in the midst of the kind of margin call season, the deleveraging that is taking place across our financial system. Now, many of you have sent questions wondering what the impact of ETFs on this is, of machine trading, algorithmic trading, and so forth. And there is a yes and no sense to what we're talking about. A lot of these things get all lumped together and they're not all the same thing. A bunch of machines piling on a cell in high frequency trading can, in fact, exacerbate selling in the moment, but that can't, by definition, last for too long because of the efficiency of markets. To the degree that machines oversell from where market actors want to clear,

market actors would come in and buy and push those prices back higher. So it can indeed exacerbate volatility in the moment, but at some point it gets tired as the excuse. So the answer is no, the market is not down 8,000 plus points because of machines. But yes, the intraday volatility is exacerbated by machines. However, machines and high-frequency trading are different than ETFs. ETFs are basically single security baskets that can trade as one stock but represent a full exposure of a particular index, the most common being, let's say, the S&P 500. And because of the trillions of dollars now held in these vehicles, it is also true that that has served to exacerbate either the buying or much more frequently lately, the selling of securities in the final hour of trading as these ETFs have to average out, clean up, balance out their books into a market close and in the afternoon following.

And I have no doubt that yesterday's 2,000-point drop became a 3,000-point drop, partially with the assist of these ETFs in the final hour. However, again, those things, to the extent they may represent inefficient pricing, they can give you a bad fill if you're trying to trade in the middle of them. They also, though, cannot be used as an excuse for sustained market downward pressure because by definition, they clean themselves up through time. So this is the current phase that we're dealing with in the markets. This is not healthy, it is not good, and I believe that we have to navigate through the kind of forced selling environment and the additive pressures it puts in our system before we can get to the true fundamentals. But in order to understand the fundamentals, we have three intervening catalysts,

and I'm going to even add kind of a fourth as a supplemental that needs to be discussed as well. And then once we go through these catalysts and intervening factors, it'll help us to discuss what the next phase of markets would be, and I'm going to lay out for you a base case, a bear case, and a bull case. And then from there, go into the portfolio implications and more actionable conclusions from all of this. Now, the intervening elements into everything going on, first we'll discuss is the monetary policy.

I confess that if I had been a betting man, and I'm in no mood to bet at all right now, the reality is that the decisions the Fed announced on Sunday afternoon, I would have expected would have rallied futures hard overnight, and they did not. futures hard overnight, and they did not. And in fact, we were in kind of a free fall in markets, and you saw the result in the stock market yesterday. I do not believe I was wrong, though, that their impact was huge in the financial system overall. It's always very difficult to prove a hypothetical, but it is entirely possible markets could have been down another thousand or two points apart from that Fed intervention to the degree that it would not, had not lubricated money markets and financial markets the way that it did. And it could have exacerbated more force to downward selling. But regardless, the stock market was dealing with an unbelievable – first of all, it had rallied 2,000 points Friday. So as of 12.30 p.m. Pacific yesterday, the market was just flat from where it had been Friday.

It was up 2,000 Friday and then down 2,000 yesterday, and then it piled on an extra 1,000 points of downside in the final half hour. points of downside in the final half hour. But the, what was the point I was making? I believe that the Fed's announcement of going to zero interest rate policy was the least important of what they announced. I think it's important longer term in the sense that whenever normalcy returns to our world, you will be looking at risk assets that have to be priced against the 0% interest rate again, and there is going to be absolutely no pressure, no burden, no desire, no guts, no anything to get off of that. So savers, CDs, money markets are going to go down to a 0% rate for a long time. It has nothing to do with economic recovery. It has nothing to do with navigating coronavirus.

But incidentally and anecdotally, people who borrow off of, let's say, credit lines secured at their financial institution that are, let's say, a point over the Fed funds rate, the Fed funds rate is zero. So all of a sudden it has brought down the cost of borrowing for almost all reference rates across the world, particularly for U.S. investors. Now, the zero interest rate was well baked in. It was known if the Fed didn't want to do it, it really wouldn't have mattered because the futures market was telling them they had to do it. But I think it's a bigger deal in a year and six months and a smaller deal in the immediate aftermath of the coronavirus. However, the QE4, $700 billion of money they are adding to their balance sheet to put into the excess reserves of our banking system, and $500 billion of that in treasuries,

but $200 billion of that in mortgage-backed securities. It's the latter that I think is the bigger deal. Mortgage rates have collapsed in response to treasury rates collapsing. There is significant more equity in people's homes than we had at the time of financial crisis. There are very few people who can't refinance who want to. And yet I believe that you have a really, really improved

I'm getting notes that there's static coming. So what I'm going to do is go off of my little earpiece and just pick up my phone because I'm not hearing the static myself. do is go off of my little earpiece and just pick up my phone because I'm not hearing the static myself. Okay. I assume someone will beat me if they can't hear me. So hopefully this is better. I apologize for that. Okay. The static was coming from my earpiece, so please forgive me. As far as the point I was making about mortgage-backed securities, there were completely money good baskets of bonds, Fannie, Freddie, very collateralized, securitized mortgages. Really, the asset class that has been and you would expect to have been performing the

best over the last few weeks, that were in complete disarray at the end of last week as a result of that forced selling. People turning to the thing performed best in their portfolio, needing to sell, needing to rebalance, needing to allocate, needing to reshift, and getting very bad bids or getting no lubricated markets at all. The Fed now has come in and is buying, and that is a kind of instant fix to that issue. At $200 billion of firepower, the mortgage-backed market opens up. It also enables mortgage rates to clear at a market level and continue to facilitate this refinance boom that has been taking place with treasury rates collapsing. So you had that, and then a commercial lending facility announced this morning.

The commercial paper market had largely dropped out. That will be very necessary to clear up a lot of the problems going on in the small business world. They're kind of unrelated just to the Fed. It involved a lot of global coordination, unrelated to just to the Fed. It involved a lot of global coordination, but swaps with foreign central banks are a major part of their policy portfolio here. And then the part that I think has gotten the least amount of attention that whether it is in this abnormal phase of markets or when we get to a more normal element to try to heal the economy is going to be a very big deal. element to try to heal the economy is going to be a very big deal. They have stopped charging banks for interest on their money held in excess reserves, and they have scrapped bank reserve

requirements. So you just have a significant boom to banks to be able to try to incent them to lend and continue their normal operations and leave them with ample amount of liquidity in the system. Again, they had no shortage of assets. Treasury bonds are highly liquid, highly safe, but they aren't cash. You can't spend a treasury bond. So banks holding a lot of assets like that in their balance sheet was clogging up the system. What was needed was cash for assets. So the heavy involvement of the Fed in the repo market to deliver cash to banks and the heavy involvement of the Fed in scrapping reserve requirements is,

you could adequately call this entire monetary bazooka the kitchen sink. And as I said before, it's not about consumer borrowing. That's just a side effect. It's about functioning credit markets and ample liquidity in the system. I believe these things will prove to be efficacious, but not in short order, not until we have a bit more normalcy. Now, this brings us to the fiscal policy side. It's really incredible that we're already talking about phase three of it. And I would argue that phase three will end up being the kind of fiscal bazooka. Phase one sort of came and went, and that was just a real immediate kind of emergency measure, mostly small ball stuff

in hindsight, $8.3 billion. It was already passed for allowing for free testing and medical care and things of that nature. behind the scenes and passed very bipartisan. There were about 30 no votes, but again, out of the size of our House representatives, mostly bipartisan acceptance of support for paid leave, unemployment insurance, and other things like that, mostly targeted at weaker and vulnerable people most victimized in this mess. The element that they're now looking to is much more significant, and I'm going to have a lot more details in the days ahead. You get some stuff out of a press conference, but then you have to go kind of talk to sources you have and other people and try to unpack it a little further, but then also try to handicap what's really going to happen politically, what gets said just as a means of a first shot across the bow

and then where does it end up. Look, they are floating the idea of a $1,000 check straight to Americans. This obviously is something that's been done in the past in one form or another, has been discussed in various elements. The numbers that we were seeing this morning are that, again, they have your address, they have your income tax, and if a married couple has less than $100,000 of adjusted gross income, they're talking about sending a $1,000 check, no questions asked, and a single with less than $50,000. So the idea is that the lower ends of the income deciles to be able to provide some cash relief to people. But the far bigger element will end up

being some form of stimulus into the airlines and hospitality sectors. And I would think very much like the auto bailouts of 2008. It's hard to imagine there will be much political tolerance for the Democrats to not go along with it when they were so for it with the auto sector. these sectors. And so that has actually, in this day and age, post-Trump created a kind of bipartisan support. And I suspect that there will be a fair amount of dissenters, but that there will be adequate amount of votes to get something like this through. But again, with the details still being worked out. But $850 billion, the amount being proposed by Secretary Mnuchin, is larger than the entire TARPA bill. So this is huge. It is a significant proposal, and it's important that I give you more details in the days ahead. But I don't see this getting voted on in the next week or two, although it could. And there's a lot of pressure for them to get something done this week.

But for those of you who remember the first draft of the TARPA bill in September 2008 and then the problems thereafter, we're vulnerable to political volatility if there's a no vote before there's a yes vote and things like that. Frankly, the market would not, we would probably not be having this conversation if we were at Dow 25,000, but being at Dow 20 yesterday, 21,000 today, is one of the reasons that we're here, is because of the massive move down in markets

that are sort of serving, as our friends at Strategist Research call a vigilante telling the market, telling Congress that they need something done. So my own assumption is that what gets done will have some things in it that I think are ineffective, some things that I think are very effective, a lot of things in it that I will probably think are unfortunate, but it will be totally irrelevant what one believes ideologically about it. The question will be how it impacts markets. And then, of course, what the longer term impact is. And again, if I'm a betting man without knowing all the details at this time, my conclusion

is that it will be short term effective to markets, but will invite other long term issues, most obviously its impact to national debt. Then the third intervening catalyst that is kind of at play as we go from dislocated markets to whatever the next phase of markets will be is the health factor. And there's nothing more important than this. This is, I think, the most frustrating, is that I do not know how one could possibly position a portfolio around the assumption, I believe I mentioned earlier, that in our nation of 330 million people, we presently have 5,500 known active cases. It's surely many, many more, and 97 deaths.

To assume millions of fatalities in a portfolio presumption with the possibility, particularly some of the draconian measures that have been taken as of late, that there will be a far better health result, I think is incredibly dangerous. But then on the other side, to fully assume that there will be absolutely no health impact and that all of it's overblown is also equally dangerous. What we do know is that if everything goes as well as we could hope from a health and science standpoint, there is still probably the reason we have a more positive health and science outcome will be because of the things we have to do that are damaging to the economy

with these sort of isolations and social distancings and all these other new expressions that we're never used to saying before. So you have a nation on a virtual lockdown right now, particularly in certain areas. There's a lot of, you know, good about that. There's a lot of bad economically. There's a lot of bad socially. There's, you know, how long it lasts is going to make a big difference in things. But my point being to the extent that that so-called flattening of the curve, again, another expression people never heard, not to mention other seasonal inputs and so forth, age demographics, overall health of the American person, you know, that this might end up being able to have a better

outcome than is possible is a huge wild card. You will get to a point where there is bad news, more diagnoses, a breakout, a certain hospital, things like that, and yet the markets don't respond. And that will be where I believe we can say that things have really turned, that the worst of the coronavirus immediate impact has been priced in. So from the kind of dislocated state of markets currently to these various intervening catalysts that are somewhat unknown with a wide array of possibility, particularly around the health result, it brings us to kind of the next phase. And I would suggest that a base case, a bear case, and a bull case are all in order. And that base case would be that this is sort of what the kind of moderate,

median-level expectation could be, is that you will most certainly have a second-quarter GDP debacle, as violent as anything since the Great Depression, just as that consumer number backtracks so substantially and every other element of economic activity backtracks. It is very expected. Now, again, if it backtracks 7% versus 10%, is that what's the difference? Probably not a whole lot. The point being, it's very well baked in. The silver lining in the base case is that there's just simply no question that we entered this violent reversal in economic fortunes from a position of very strong economic positioning. Industrial production had really picked up. Unemployment has been very low. Wages had really elevated. So to enter recessionary conditions or contractionary conditions off of weakness in an economy like we did in 2007-2008 is substantially more vulnerable than to enter from a position of strength. But nonetheless, the suddenness and violence of what the economy is

going through right now in real time is at not for debate. Now, keep in mind, this is the base case. This is what we already know. I think that the base case then would be that the rebound takes place in the late Q3, early Q4, that probably Q3 is a goner too, as the tail effect from Q2 continues to lurch, and that you end up with a technical recession around two quarters of GDP contraction. And yet, from a base case, markets that begin to kind of handicap the new realities much sooner than October of this year, but certainly have to kind of deal with the post-coronavirus economic effect. Now, the bear case is really almost undefinable because we just simply don't know where the health pandemic will go. And so to the extent that you could end up with much longer health problems, much longer containment, much

more draconian measures, it is not even just the magnitude of what measures may be required, but the time, the length. If something has to go for a year, that's very different. It has to go for a quarter. So this would not be our outlook any more than the bull case I'm about to lay out is our outlook. The base case is our outlook, but you have to be allowing in your positioning for both a tweak to the left and a tweak to the right. again, even in the bull case, a second quarter GDP debacle with a significant V-shape rebound in Q3 that there is such a pent-up demand and it comes back as early as July and certainly strongly in August, September. Conferences rescheduled, vacations rescheduled, and that combined with fiscal stimulus, combined with monetary stimulus. By the way, I say these terms totally agnostic about whether or not one likes them or believes in them, wants them ideologically. I'm only referring to

the economic impact in a measurable sense. To the degree, monetary fiscal stimulus on top of a V-shaped rebound that you could, and then of course, really highly contained health damage. What would be the way that you end up with highly contained health damage? This is the bull case. It's not our base, but this is not something I believe is outlandishly proposed. It is entirely possible that everyone talking about how the cases are far higher than what we know now because of low testing, they're completely right, and that there will prove to be significantly more cases than we presently know, and that by the time we know them, the people are already cured. That there is such a delay in getting testing, and for

healthy people, getting the flu-like symptoms, finding out it was coronavirus, they're already on the mend by the time they even knew, that, let's say, could total into the many, many thousands, but would not represent this sort of systemic health risk. Now, again, there's other considerations that could tail out of that. I'm purposely right now giving that bullish case. Very contained optimistic health result combined with the monetary and fiscal bazookas to a Q3 V-shaped rebound. Maybe you don't even have a technical recession because it didn't go two quarters, although it would sure feel like one with the violence of the contraction we're going to have in Q2. And then you go into the fourth quarter,

perhaps with a more unified country, a more grateful country, an economically rebounded country, and one even with various industries and companies that were deeply bruised by this distress, an overall brighter position. So I would pray for the bull case, whether I was an investment manager or not. I would expect the base case and I'd be prepared in my portfolio expectations for the bear case. I hope that that framing is helpful. So what does this mean in terms of portfolio implications? Let's get the easy part out of the way first. Other than people who absolutely have to raise cash and absolutely want to be rebalancing at this time for opportunistic reasons, and other than people who have margin pressures, right now selling heavy amounts of municipal bonds that are money good

and taxable bonds that are money good is an unwise thing. That could change in a day. It won't. It could change in three days, I hope. It could change in three weeks, more likely. But there are still enough technical idiosyncratic distresses in financial markets that until those things breathe easier, it is not a wise idea to be indiscriminately selling out of bonds going into stocks. Now, does that mean that bonds are not overpriced in a functional market? No, because they are. And does that mean that stocks are not underpriced in a functional market? No, because they are. However, our position is that the rebalancing we plan to do out of bonds into stocks, which is done for two reasons. One, because of bonds offering an inadequate return

and income for the next 10 to 20 years that we care about for clients. And A and B, stocks offering extremely generationally high yields that can be bought at lower prices. In order for us to take advantage of that, and it would be at different ways, different weights, different measurements across different clients, risk appetites, and particulars. But in order for us to take advantage of that, we need the market to normalize better so that we are not selling inefficiently and buying inefficiently. So our plan will be when we see normalization in the bond market, when spreads come in between bid and ask, to take roughly 25% to 30% out of our bond positions. So to put that in context, that represents about 7% to 12% of a total portfolio. If one has as low as a 25% bond allocation, one has as high as a 40% bond allocation, 25% to 30% out of that times that you're waiting would equal about 7% to 12% that would then come into cash, not directly into equities. And the reason for that is not phase one. It is not this current phase of market dislocation. It is phase two, which is that bear case versus base case.

That while we believe equities are, from a long-term standpoint, profoundly underpriced, we are completely, humbly aware that the market could drop another 2,000 points in a minute, and in fact has been doing so over those last several days of distress, as we talked about yesterday. So we want to be able to prudently move cash into equities, but do so in a more averaging, prudent sense, other than for our most highly opportunistic clients that are expressing a desire to go all in. We think that it will enable people to take advantage of what will be very distressed prices and yet enable us to not have the risk of blowing more dry powder when, in fact, there are more bearish and recessionary and distressed cases that could potentially lie ahead.

Whether the Dow is at $18,000 or $25,000, we have no problem holding some cash. And the only place to get that from is fixed income at this time. I do want to address where the portfolio implications for alternatives may be. They have certainly been the shining light in client portfolios. There are two different reasons. One is many don't get marked. So you can't even see what's going on inside of a menu if you want to do. And that provides a lot of psychological relief, but also because the underlying assets are of themselves. When they're not exposed to the dangers of liquidity, of forced selling, of deleveraging, as I talked about earlier, then you have a more stable NAV, a net asset value, and the underlying credits and real estate and financial positions that make up different hedge funds, private equity, real estate, credit funds have performed much better.

So the alternatives have been more of a safety valve, and that is what they are there for. So to the extent that in some of the more liquid alternatives, there may be a little stress in the pricing. It is, again, related to that mismarking and dislocation taking place in capital markets. So out of this entire lesson, what do we learn? For those of you on the line or clients and want me to talk about individual stocks, we cannot on a public call talk about individual stocks. I don't know what that was. I can't talk about specific stocks right now, but what I can do is answer your questions if you email them, although I think you're going to get answers to your questions in our weekly portfolio holdings report tomorrow, because obviously I'm well aware of what the couple of stocks are that most people have questions about. But to the extent that

there's continued distress in the oil and gas sector, we have a strategy for how we are dealing with it. And then we'll address the individual names shortly. Okay, now, there are so many questions here. I'm just going to start going through them in order. And please don't be offended if I don't get to your question on the call. But like I said, I'm pretty determined to get back to everybody on the questions.

A lot of it will end up being after the market closes today into the evening, but expect an answer from us. And I hope that I've done a good job consolidating questions that came in ahead of time because there really were so many questions that kind of overlapped with one another. I'm not going to be reading anybody's names on the questions. No one gave permission to do that, and I think it's totally unnecessary. But someone during the call did ask, if we had a liquidity waiting to be put to work,

what would be our strategy for entering the volatile market? And so this is a little bit different than what I just addressed on the rebalancing issue. This is referencing outside cash that comes into the portfolio. And this is something that is very important at the Bonson Group because we only manage money on a custom basis. We don't have to give the same answer to every single client. Okay. The answer is that for some people who are able to tolerate additional downside, we might be more aggressive going in. And for the kind of more prudent middle of the road answer,

going in. And for the kind of more prudent middle of the road answer, we would be just tethering it in piece by piece. So if someone added new cash to take advantage of the distress and equity markets, do we believe that in a year, two years, five years, these are just simply unfathomably great prices to enter? Yes, we do. The problem with that diagnosis is not about the two-year timeline or let alone 10-year timeline. The problem is entirely around what happens in the next two days, two weeks, two months. So some clients, there's a few categories here. Some clients have the ability to be totally insulated from that short-term volatility. Some clients have no ability to be short-term insulated from it. It's very distressing to them. Nothing wrong with that, but it affects their psychology and emotions a great deal. And then some clients think they

have the ability, but really don't, just because they kind of find out, you know, we're all like that to some degree. Sometimes you don't know until you know. So where we can do an honest assessment on a case-by-case basis, we would make that decision as to how aggressive we wanted to be tethering cash in. But in a more moderate, median, middle-of-the-road response, our answer would be that cash that is provided to us to be deployed in a portfolio would be deployed over about a six month period right now, subject to change with 10%, 20% out the gate, and then just doing another 10% or so per month while we continue to go through this period.

That is the answers to how we'd be averaging in cash. Thank you for the question. Okay. So to the extent someone wants to know how we take advantage of depressed prices of stocks, this is the answer. Rebalancing out of fixed income and doing so prudently and slowly, as I mentioned before. Someone entering the market who has not been invested before, they're not just looking to add new cash. They want to invest while low, but at the same time, they're uncertain. I would just give basically the same answer I just did. It would

be a very custom conversation with that client about their tolerance, their kind of willingness to withstand ongoing volatility and take advantage of these prices while also being humble around the economic and coronavirus uncertainty that we have. One person asked if economic activity will be significantly suppressed as long as the special measures, social distancing are in place. The economic activity by definition will be significantly suppressed as long as special measures are in place. Maybe Peloton and DoorDash and other companies that have a strong home use to them may not be. By the way, I'm in no way recommending those stocks. We don't own them. I'm mentioning

them as consumer brand names to give you an idea. But I'm saying on a macro level, answering this person's question, economic activity will be significantly suppressed. And then you said, well, those measures stay until a vaccine's available. The answer there is no. They will be keeping these heavy measures on until there is a flattening of the curve, meaning a lowering of the diagnoses. Once they feel that that contagion effect is controlled, that's when you'll expect to see some degree of societal normalization. I don't know if it's going to be two weeks, two months when you'll expect to see some degree of societal normalization. I don't know if it's going to be two weeks, two months. No one seems to know. I think that's why everyone turns the mute off of their TV the second they see these White House officials going on a

press conference. But the reality is that, yes, economic activity will be significantly suppressed. But allow me to say what I think may be behind the question, which is what the market impact to that is. And I do not know when markets will begin to discount the future in a positive way. And I certainly don't know when the future itself will become positive. But I do know that the market will be a leading indicator, not a lagging indicator. I would just go back to the most violent and dramatic illustration of this in my lifetime, which was the mortgage crisis, Great Recession of 2008-9, and going into 10. Unemployment was still 10% during Obama's midterm year in 2010. That recession was horrific,

lasted a very long time. It was the most significant economic contraction since the Great Depression. But stocks bottomed when? March 9th, 2009. By the time an investor could look up to see that the economy was still way down, stocks were up 25% in 2009 on the calendar year. They were up 40% from their bottom and then up again. High teens in 2010, kind of a flattish year in 2011, because of European stress, and then so forth and so on. The Fed kept their heavy quantitative easing on, even through that. And in 2013, you had a 30% recovery, we all know the 400 to 450% recovery, you ended up getting total. So my point being that it is very difficult to say, I want to formulate my stock market plan around what our expectations are for social distancing and economic suppression, because the market will be at some point able to price that recovery in

in advance of it actually happening. That could be a long time from now. I pray it isn't. But my point is, is that timing this thing is so difficult. There's a series of questions from one who asked how gold was reacting. And I said earlier, it was down rather significantly, certainly for what gold people would want to happen. We do not own gold. We never will own gold. We don't believe it is a safe haven because of the very reason we talked about. When you need it most to be a safe haven, it gets sold off as well. And then along the way, you don't get paid anything. So in all normal periods, which is where we spend about 95% of our lives as investors, normal periods, and I know the last few weeks

have been abnormal and painful, but in the other 95% of the time, you want to be getting paid. And gold doesn't do that. And then when everything hits the fan, you want protection. And gold generally doesn't do that either because of the reality of these forced compressional markets. So I know not everyone agrees with me on it, but that is our experience. And ultimately, we want an internal rate of return out of the things we're invested in. So asset allocation, how do you withstand economic, social market uncertainty? The answer is through asset allocation. Has asset allocation been able to withstand it? No. I mean, it hasn't withstood it if that means providing no downside.

it hasn't withstood it if that means providing no downside. Bonds are down a little bit in the recent days for the reasons I laid out. Alternatives have held up pretty well. Stocks are all down across the board. Maybe European is down more than U.S. and emerging more than U.S. or U.S. more than emerging, but it doesn't really matter. Wherever you've been highlighted as a global equity investor, you've been hit hard. And as I said earlier, even safety zones. Now, healthcare and consumer staples happen to have performed a bit better. We're heavy-weighted there, but then we're heavy-weighted financials and energy, and they've been hit worse. So we've been in the two best-performing sectors and the two worst-performing sectors all at once to kind of even out the teeter-totter of that. And at the end of the day, that diversification

is important in a normalized environment. And when you get to an abnormalized environment, when correlations go to one, it becomes much more difficult. Okay. I think, again, you have to forgive me because a few of the questions that I'm looking over right now have to do with some form of the algorithmic trading and things like that. A real thoughtful question here about what we see for building and real estate development industries. Does this drop in value in publicly traded equities represent an exodus of cash to other investment vehicles like real estate? represent an exodus of cash to other investment vehicles like real estate. It's a very commonly held view, by the way, that people run from the distress of equities to the safety of real estate. And I have to point out, if you look at the hospitality sector right now, hotels are at 0% to 20% occupancy. People can't go to work in offices. The retail-oriented

equities are getting destroyed. There's all kinds of distress that is equity-like that passes through the real estate side of the economy. So there is a yes and no answer to this. Fundamentally, of course, there's no difference. Real estate doesn't have a different mind than the operator of the real estate. It is worth the cash flows of the entity inside of it, whether it's a family paying rent or a business paying rent or a retailer paying rent. And so when all those rents are damaged in a cash flow constricted economy, it's going to affect the underlying value of the landlord, the brick and mortar as well. The difference is, and this is legitimate, and it was a big theme of ours

entering the year, the illiquidity. What has decimated stock investors last few weeks is the fact that everybody can sell. And yet when you can't go sell a big building, it really helps. It doesn't mean that the underlying value, if someone were to sell, would not be lower, but I'm sure to you it would be right now. So there's kind of a mixed bag on it. My answer is not to delegitimize the role of real estate and illiquidity in a portfolio. I'm all in favor of it, but I would not say that it means that they don't have challenges in underlying value. It's just that technically speaking, you get to kind of be hidden from it a little bit. Someone said, why not sell fixed income and reinvest in equities? Because equities now are paying higher dividends. Well, they were paying higher dividends before too. And now those

dividends have gotten even larger. And you will have, I think, at the aftermath of all this, with the zero interest rate policy of the Fed, and equities under such distress pushing their dividend yields higher, a record level of spread between income you can get from stocks and income you can get from bonds. So I got to deal with the next few weeks, and we got to deal with the next few months out of a mini or major recession. But I also have to deal with the next 10 and 20 years, which is something I've been saying ever since the financial crisis, something I alluded to an investment committee yesterday. But I'm telling you, my friends, bonds are not

going to be a source of income for the rest of your life. And stocks will be a source of income for the rest of your life. And this is a paradigm shift from 20th century thinking. Some of it is good. Some of it is bad. It's bad in the sense that they've taken safety away from seniors, retirees, savers, conservative people. So I'm all in favor of the presupposition behind the question. However, the reason not to just simply do a carte blanche is all a byproduct of one's tolerance for volatility. Your bonds are not dropping 30% in 16 days and equities just did. So despite the fact that the income is much more attractive on the equity side, we have to temper that with one's tolerance of price volatility.

Okay, let's continue to work through these here. One wanted to know why individual dividend growth stocks versus a kind of high-quality mutual fund that does the same. And I think it's a great question, and we've really gotten to see it play out here. It has a lot to do with tax reasons. I don't want things to go down, and I sure as hell don't want them going down 30% in 16 days. However, we will be able now to capture tax loss sales that will impact our clients for years to come. That's never something I want to be able to have happen, but when it happens, I want to take advantage of it. We can do things on a customized basis with individual stocks to

manage the tax efficiency. But as everybody that was piling out of dividend mutual funds has been selling, it's triggering tax bills for people because those stocks were still bought at a low basis. And now they're selling out at a capital gain, even though they're way down in price from their highs, that capital gain will get passed on to the investor. And unless they sell out of the fund altogether, they can't capture any tax loss. So mutual funds, in this case, become an utter tax disaster, where we not only have the ability of forward-looking selectivity in the stocks we buy versus backward-looking, which is what the funds do.

But we also are able to manage the tax efficiency for clients. Forgive me, a lot of the questions similar around how we're approaching risk tolerance and how you kind of want to be on the offensive and yet still sort of manage those things. Another thoughtful question here about the demand side, to what extent are the Fed ineffective or effective around the demand side of this economy? And I think it was something that I alluded to earlier. It is entirely about lubricating our country's financial systems. It is not related to stimulating consumer demand. They want banks to be able to loan. The commercial paper facility is to allow banks to roll over their own debt. They have high confidence

in the solvency of the assets, but the liquidity gets called into question. And so that is the reason for the Fed to do it, for good or for bad. My own views, no one asked here, but I'm just going to get out of the way because I know I'll get asked, and I'm not going to have time to write about this for some time, even though there's nothing I'd love more than to sit down and write a position paper on this. My own view is that the Fed should never have done what it did, but the Fed did it, and now they have to kind of lay in the bed that they made. For those in the distribution phase of their investment life cycle with a reasonably conservative asset allocation, would you ever recommend getting out of the market

based on a limited time horizon? And the answer to the question is no, based on the facts I have there, I would recommend being out of the market already in a conservative asset allocation, because a conservative asset allocation would never be all in the market. So I would presuppose that if one had a conservative asset allocation, they might only have 20, 30, 40, 50% in equities, and therefore they already had 50, 60, 70% out of the market, whether it was fixed income, whether it was alternatives. There would be other areas, you know, cash, et cetera, that would be diversifying their balance sheet. So therefore, that portion that is in the highly distressed phase of equities would have much more ability to withstand the craziness of times like this.

20, 30, 40% in equities and go to cash with that? The answer is no. For one thing, the question actually gave away the answer. It said those in a distribution phase. And I can't distribute from cash paying nothing. I would just be eroding the principle. So I'd be taking away from the net worth. I'd be making someone poorer. Now, someone gets poorer on paper when equity prices drop. But when you're not diminishing the quantity of shares you own, and if you believe the price of those shares will through time recover, no one has gotten poorer, and yet the income need was still met through the dividends. is not jeopardized. You could have issues with a given company. You could have a suppressed dividend growth. The lowest year of dividend growth we ever had was 2008. 2020 is surely going to be lower dividend growth than 2019, 2018, 2017 were. But again, lower dividend growth does not mean not being able to pay out that full income. Going into cash from stocks, unfortunately, that full income. Going into cash from stocks, unfortunately, for a distributor, lowers the ability to make good on the money. Okay. Let's see here.

How long will it take to see some normalcy in markets and get back to most of what has gone down in the last few months? I would just, again, answer that question in two different phases. One is the market dislocations. 1,000-point up days, right now we're up 760 points in the Dow. We're up almost 5% in the S&P and NASDAQ. That might feel good to people. And I really do prefer it myself at this point relative to down at 3,000 point, 2,000 point, 1,000 point days. But I just have to tell you, as long as we're having up 1,000 point days, we're not back to normal markets. As long as the VIX is still at 74. Now, the VIX is down 11% today, but as long as the VIX is up above 50, above 40 really,

but certainly above 50, there's nothing normal going on. I told my investment committee this morning, I have about 20 indicators I'm looking at right now for normalcy, and zero out of 20 are indicating normalcy. So the first phase is when you have functioning capital markets again, but that is now, as I said, a different answer than when you, quote, get back to most of what was down. I suspect that there will be something like this. Please don't hold me to this. I'm trying to give you a narrative more than exact numbers. If the Dow is at 21,000

and people want to know when it's going back to 29, I think there's a point coming where there will be 4,000 to 5,000 points, roughly half of the downturn from the high to low that will come very quickly and will be very subject to being missed by people that are on the sidelines. And by the way, as a percentage represents an incredibly attractive return going from 21 to 25,000, you know, you're talking about roughly a 20% return higher. But then I think that the second leg of return will take more time. It will depend on the depth of the recession. It will take on the magnitude. It will depend on the magnitude of this health epidemic. And it will also matter how we end up pricing things going forward. Because far past the two phases of recovery needed, we also have to deal with what it's going to be like living in a world that the Fed has zero interest rates. So there's a lot of complexity ahead, but that's my basic answer. Short-term, half of them move back.

Mid-term, the other half back. Long-term, more questions. Okay, I'm going to go ahead and do two more questions. I'll let everyone get back to their work days and lives. And, of course, like I said, I'll invite more questions from there. With tax returns expected soon, is it a good time to make a large buy in the market? No, don't use your tax money to go into the stock market, pay your tax bill, although there is a very good chance that they will be extending your

tax due date till June as part of this fiscal stimulus measure. And now at this point, it looks like I'm starting to repeat different questions from different people. Okay. I'm going to go ahead and leave it there. I do think that a lot of the questions I have are now kind of rhyming with other ones I've already answered. So I hope this format has worked for you. I do believe that it's important we can continue to communicate heavily with you. I speak for every advisor at the Bonson Group,

and right now I'm really talking to those of you who are clients of ours, that we care about you very much. And there are some of you that we've had relationships with for 20 years, some of you that we've had relationships with for 20 days. But I will tell you that we are extremely relational in the way we view client engagement. And nothing about these swooning markets is easy for us when we know that it's causing our clients that we care about pain. And at the same time, as empathetic as we must be through what you're going through, it really is our job and our fiduciary duty, both legally but also morally and economically, to keep you from making mistakes. You can always say, don't you wish you'd done this different or this different.

I have spent sleepless nights wondering what we could have done differently here. But I have been through three black swan events now in my career. I've been through 50 to 60 cyclical events. And I think I've handled 50 out of 50 the right way, cyclically. Black swans, there is no right way because you just don't see them. You don't see a terrorist coming through with an airplane at a building. You don't see a global flu epidemic coming. You don't like this. You don't see the depths of the financial crisis that took place in 2008. These are the events that are by definition, unfortunately, what equity investors sign up for. And I actually think that many equity investors didn't sign up for the rapidity of this one.

Yeah, sure, 20% to 40% drops happen. But happening in 16 days, it's just been awful. So I want you to know that we're sorry, but we also are committed to doing what we can so that in three months, six months, and a year, we don't compound the awfulness of what's happening in our society right now with regret over a decision that we can't undo. I cannot promise you that yesterday was the bottom in the market. I would have no basis for doing that. We're still totally unclear where the fiscal package is going. We're totally unclear where the health results are going to go. But I can promise you that the right thing to do from a fundamental standpoint and the lessons of history,

which is all we have to go off of here, the right thing to do is allow us to manage your liquidity, to manage your temperament, and for you to know that we're doing everything we can to give you a good result on the other side of this. So thank you for your trust, faith, and confidence in the Bonson Group. All of my partners, my colleagues, my whole team, we are a family at the Bonson Group. We are here for each other, and we're here for you to close this gap. And we thank you for your time today. And with that, operator, I will end the call. Thank you.