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Ripping Up the Playbook

In 2013 Jeffrey Laurie, owner of the Philadelphia Eagles, hired Chip Kelly as the new head coach of the Eagles.  Kelly, head coach of the University of Oregon, came to the NFL and “tore up the playbook” installing his up-tempo offensive scheme, heretofore untested at the NFL level.  Kelly lasted less than three years with the Eagles and Laurie replaced him with Doug Pederson, a coach with more traditional NFL background.  Pederson essentially “tore up the playbook” once again, leading the Eagles to their first Super Bowl victory just a few short years later. 

The playbook for the financial markets seemed solid as the new year began.  Stocks traded up, interest rates were low, inflation remained quiescent, and Fed policy somewhat accommodative.  The economy continued to grow, with expectations that Gross Domestic Product, a measure of the total economy, would grow faster than preliminary reports of growth in the final quarter of 2019.  Strong job growth contributed to declining unemployment claims, an unemployment rate of 3.5% (among the lowest in recent memory) and discussions of labor supply shortages across many industries.  The news, highlighted in the State of the Union address, may well have prompted Nancy Pelosi to “tear up the playbook” in frustration at the end of the speech.  Little did she know that just a few short weeks later a combination of events would make those histrionics seem trivial.

As the stock market rose to new highs in mid-February, two unrelated events combined to disrupt everything.  The novel corona virus delivered both a demand-shock and a supply-shock to economies throughout the globe, while an oil price war initiated by Saudi Arabia and Russia drove the price of oil to new lows and threatened the existence of domestic energy exploration companies.  As Covid-19 quickly morphed from an outbreak in Wuhan China to a global pandemic, governments imposed stay at home orders with dramatic consequences.  Demand dropped as consumers on lockdown curtailed purchases, while corporations were forced to curtail operations and furlough employees.  Manufacturers that continued to operate struggled to overcome supply constraints as global supply chains were disrupted.  In just 23 days the steep decline in the stock markets exceeded the crash of 1929.  Stocks rebounded somewhat during the last week of the quarter but the rebound was not nearly enough to offset the steep decline. 

The playbook for the Covid-19 crisis has been clear, the response for the oil price war less so.  The Fed cut interest rates to near zero with two moves in rapid succession, and announced several measures to backstop the financial system.  The Fed expanded repo operations and dollar swap lines to provide liquidity.  They expanded asset purchase programs for mortgage securities, investment grade bonds, and for the first time included non-investment grade (junk) bond ETF’s, as well.  The inclusion of non-investment grade ETF’s is significant because it demonstrates how far the Fed will go to keep the financial markets functioning.  At the same time the Federal government announced stimulus payments directly to taxpayers, expanded unemployment benefits, small business lending programs, and a payroll lending program designed to compensate smaller companies who retain employees at 2019 levels.  Remaining unresolved, however, was a strategic response to the willingness of Saudi Arabia and Russia to drive oil prices to unsustainable lows in an effort to crush US energy exporting capacity.

With no expertise in the coronavirus, my knowledge is limited to what I have read, analysis often written by those who have no more expertise in epidemiology than I do.  So while I claim no medical qualifications, I believe that our market-based economy fosters innovation that will ultimately contribute to a cure for the coronavirus and defeat the pandemic.  It will take some time to move past the pandemic lockdown, but as we do the dynamic nature of our economy will reassert itself.  The process has been difficult, but it could yield structural changes that could potentially benefit our economy in the long-term.  Companies that became overly reliant on global supply chains, based solely on cost considerations, could move essential operations back to the US, expanding domestic employment.  Increased capabilities to work remotely could reduce employee costs and improve productivity.  The adaptability of our economy and resourcefulness of our people will enable us to survive this crisis and emerge stronger for it.  As that happens, we believe that the economy will rebound and the financial markets will improve.  In periods of extreme uncertainty it is important to remember that market volatility can potentially create investment opportunities in structurally sound, well managed companies.  While the current severe financial distress will impact companies throughout the economy, we believe that our focus on balance sheet quality may benefit our investors.  Our playbook will be to avoid over-reacting to emotionally-driven market moves and continue to invest in companies that have strong long-term prospects trading at attractive valuations.

Sincerely,
Daniel A. Morris

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