“While the Optimist and the Pessimist were arguing over whether the glass was half full or half empty, the Opportunist drank it.” – Origin unknown

The current investment climate is the most difficult period I have ever seen. Much of the massive uncertainty of a few weeks ago is resolving, so we are seeing things settle down a bit. This is welcome, but new risks have emerged that seemed improbable or unthinkable just seven weeks ago that are causing new uncertainty. My aim in this missive is to provide a deeper dive into the new risks that have emerged while reminding you to remain hopeful and optimistic. I also discuss recent IRA portfolio moves.

For those of you we currently serve, you know me as a relentless optimist on free markets, people and their ideas, and capitalism. I believe in our system of private property rights, freedom to contract, and the rule of law. Despite its flaws – and there are many – our system is superior for the greater good. I remain, therefore, an unapologetic optimist for reaching long-term financial goals by investing in companies and the people who run them. That hasn’t changed.

But it’s far from clear whether we will bounce back quickly in what is known as a “V-shaped” recovery. Given the shutdowns, we are flattening jobs and businesses along with the “curve”. We simply do not have a historical example of shutting down a modern economy. I was more comfortable with the so-called Great Recession of 2008. It was a jarring, awful event. Reduced to its core, however, it was mostly a good, old-fashioned financial panic brought on by greedy, speculative behavior that had its roots in well-intentioned, but controversial government policies. Financial panics have frequently happened for hundreds of years.

Emerging Risks

Here are the new risks that have emerged in the last 6-7 weeks:

• Are the lockdowns causing irreparable harm to the economy? Thousands of companies may go out of business and millions are now filing for unemployment. Even as the lockdowns subside, how quickly will we walk back into stadiums or get on airplanes? When will we eat out in crowded restaurants and bars? Nobody knows. And will customers return in time to save otherwise good businesses. The small business assistance is bold and interesting. But will it be enough and timely? If the government gets this right, high fives all around.

• Can we get back to normalcy without triggering a second wave? There is a lot we still don’t seem to know about this virus. The flu of 1957 saw a second wave that was particularly devastating. According to the CDC, it killed 116,000 Americans on a smaller population. That was 63 years ago – undoubtedly vaccines, drugs, information-sharing and testing will happen more quickly than in 1957. But there is uncertainty here.

• How many T-T-T-Trillion of government “stimulus” are being approved? Yikes! Even Modern Monetary Theory proponents acknowledge that there is a limit to how much government debt we can sustain. Will these trillions of stimulus trigger inflation? We’ve experienced both a “demand shock” and a “supply shock” to our system. – i.e., when demand returns, if supply isn’t there to meet demand, then that’s a setup for inflation. It’s not my top concern, but it’s worth watching.

• Conversely, I am more concerned about deflating asset prices if things turn uglier. Deflating asset prices are real trouble for indebted companies and people. Debt becomes more burdensome in real terms when an economy is deflating. People can’t sell their homes if the debt is greater than the value of their home. The further fear is falling demand – people delay purchases because they think prices will decline further. We have a fiat currency, and Ben Bernanke quipped that the Fed could always drop money out of helicopters to cure deflation.

• Will the massive government aid now prop up “zombie companies” that were otherwise going out of business? Even in good times, companies are sold or otherwise closing their doors. Unproductive assets then get redirected in our system through bankruptcy to more productive uses. Propping up unproductive businesses distorts this valuable market function. Japan has done this with destructive, deflationary results.

• Millions of people are out of work. Social unrest is a risk.

• Are we now more vulnerable to a bioterror event? Is the unfolding coronavirus story a blueprint for bad actors on how to attack western governments? Or maybe we’re better prepared as a result of this experience. Hard to say.

• I am concerned about the “moral hazard” that continues to be imbedded in our society as we expect government to rescue all things – economic participants increase their risk-taking when there is an implicit government guarantee. The Federal Reserve is in uncharted territory attempting to repair credit markets by buying corporate and high-yield bonds. This is a significant expansion of the Fed’s role and should give you an idea of how serious they perceive the impact this virus is having on markets.

I understand that this is a tough list. Don’t despair, but please know these emerging risks are on my mind looking forward. The good news is that the number of coronavirus deaths is far below what the models were initially predicting. There are brilliant people working on solutions, and the U.S. has always been best when we’re motivated by a common enemy. We’ll probably see new, highly successful businesses emerge from this mess. And when things improve, I believe we will see the long-term “secular” bull market that began in March of 2009 resume – a topic for another time.

IRA Account Portfolios

With all of this in mind, I have rebalanced IRA accounts three times as we’ve moved through this bear market. I am generally loath to make changes to portfolios when markets are acting up, but the world quickly became a different place with new risks in the last 6-7 weeks. Therefore, I decided to provide some defense while also providing a bit more offense as things improve – all with a keen eye on the timeless principle of matching investments to the time when you will need the money. We might end up a tad defensive if things turn out better than expected – and let’s hope that happens! But please know how serious I take the responsibility of protecting your assets from the downside while investing for the upside. This is your capital, and we are in this together. And for what it’s worth, I hold the same investments that you do.

To generate some offense in portfolios, I have added investments that should benefit from the anticipated technological wave that is coming. I believe this could be a very good buying opportunity. The new technologies coming on board will most likely disrupt existing businesses unlike anything we have seen in decades. The coronavirus is probably accelerating this trend.

For defense, I have added a bit to government and investment-grade corporate bonds. I have also increased exposure to the normally defensive Berkshire Hathaway given the enormous amount of cash on their balance sheet. If history is a guide, Warren Buffett will pick his time in this mess and find an opportunity to deploy some of that cash. Even if he doesn’t, Berkshire remains a solid company with many diverse interests. The Federal Reserve announced last week that they would be buying high-yield bonds – another remarkable move, so I have added a small high-yield bond position. In conclusion, I am deeply grateful for your trust and confidence to help you plan your financial futures. Please keep yourselves healthy – mentally and physically. I am only a phone call away if you would like to discuss things – or a Zoom meeting! Thanks for reading.