Friday, March 27, 2020

During this stressful time, we know that your health and safety, and the wellbeing of your family and friends, is your number one priority. Like all previous crises, we will recover a stronger nation. However, as the coronavirus (COVID-19) pandemic accelerates domestically and the U.S. economy, the strongest and largest on earth, has come to a grinding halt, many of our fellow citizens are significantly impacted. We are almost certainly in a recession, but the government response is of a size and scale that has never been seen before, even during the 2008 financial crisis. I am confident that the economy will endure and a three- to six-month bottoming process for stocks and corporate bonds has likely begun.

All of us at Palisade know how difficult it is to watch your investments endure the weakness and volatility that has occurred over the last few weeks.  At times, short term extraordinary events test investor patience and tempt even seasoned investors to forget long-term goals and sell at an inopportune time.  During a crisis like this, riding through a downturn with the right stocks is critical.  Our top priority remains focusing on the best managed companies with the strongest financial characteristics that can withstand, recover, and perform once this remarkably challenging period runs its course.  Managing through past crises has taught us that it’s important to keep perspective and not lose sight of the following:   

• In times of broad financial stress, all stocks go down. The stock market makes no distinction between good companies and bad companies during a sharp or sustained market sell-off. Even the best issuers, the ones that will endure the current turmoil, can trade at surprisingly low prices despite the fundamental outlook.
   
• The stock market functions on a balance of fear and greed. When either is out of balance, the hardest thing to do is not follow your human instinct (and, in fact, to do the opposite).  Fear should drive investment behavior when the market is too greedy—in other words, investors should worry when stocks are high, and everyone is celebrating.  At the same time, when fear and irrationality take hold, greed should motivate investment behavior.   By every metric, technical or otherwise, the current market decline reflects general and widespread fear that stocks will continue to drop.  We believe this is the time to have courage, patience, and focus in order to make rational investment decisions and take advantage of irrationally depressed stock prices. 
   
• The key to investment success, especially in this climate, is identifying the high-quality companies that will outperform in the longer-term. Not all companies will survive this crisis and we believe an active research and stock selection process will yield the best investment returns (as opposed to passive index ETFs).  Investors must focus on the companies with balance sheets and management teams that can sustain their respective businesses through this downturn and take advantage of opportunities.  These companies are likely to have access to capital and emerge from this crisis stronger than before.  This is not the time to invest in companies that are not profitable, are highly leveraged, have near-term capital needs, or are led by weak management teams.  Lessons from previous financial dislocations have taught us that such companies can experience permanent capital destruction and never rebound. Distinguishing which companies are which is critical. 

For bond investors, the lowering of interest rates by the Federal Reserve has only helped government bonds.  As the self-imposed shut down of the U.S. economy took effect, a domino effect of corporations and small businesses accessing bank lines of credit caused the selling of all bonds.  The markets for high yield, high grade, mortgage, and municipal bonds were literally shut down to new issuance and secondary trading.  Federal Reserve bond buying in the form of quantitative easing expanded in size and scope to levels never seen before.  Traditionally, Federal Reserve bond purchases were meant to maintain liquidity and were confined to U.S. treasury bonds, however in a historic move this past Monday, March 23, the central bank announced that bond buying would include mortgage, municipal, and high-grade corporates.  This intervention allowed for these markets to re-open to new issuance which is critical given fresh capital needs.    

Conclusion:

The coronavirus pandemic has resulted in a government-mandated abrupt shutdown of huge parts of the U.S. economy, leading to the broad and indiscriminate sell-off of stocks and bonds of all types, including treasury bonds and gold.  Only cash and the U.S. dollar acted as safe havens until very recently.  The policy response has been unprecedented: the Federal Reserve has lowered rates to near zero and, in concert with the Treasury Department, steadily increased the size of capital injections into the banking system.  Additionally, quantitative easing, or the open market purchases of treasuries, has expanded to mortgage, municipal, and corporate bonds.  This is an unprecedented expansion of the Federal Reserve’s role in protecting the financial system. As of the writing of this note, the U.S. Congress is debating a $2 trillion stimulus bill to essentially bridge the needs of workers, small businesses, and industries deeply affected by the sudden stop of business as Americans self-quarantine until the virus runs its course.

The U.S. has likely entered a recession, but I believe the economy will recover from the COVID-19 pandemic and the associated severe financial repercussions.  The size and scope of the actions that have been (or are about to be) taken dwarf the response during the 2008 financial crisis.  I believe these actions will shorten the economic slowdown and likely contain the damage.  While I believe we are observing the beginnings of equity and debt market stabilization, we are likely looking at a three- to six-month bottoming process for stocks before a new uptrend begins.    

Thank you for your continued confidence in Palisade.  We remain available to answer any questions or concerns.

Important Information:

The information contained herein reflects the view of Palisade Capital Management, L.L.C. and its affiliates (collectively, “Palisade” or the “Firm”) as of the date of publication. These views are subject to change without notice at any time subsequent to the date of issue. All information provided herein is for information purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no assurance, representation, or warranty is made concerning the accuracy of the data presented. In addition, there can be no guarantee that any projection, forecast, or opinion in the letter will be realized.

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Palisade is an SEC registered investment management firm established in 1995. Based in Fort Lee, NJ, the Firm manages a variety of assets for a diversified client base, including institutions, foundations, endowments, pension and profit-sharing plans, retirement plans, mutual funds, private limited partnerships, family offices, and high net worth individuals.

Past performance is not a guarantee of future results.