Dear Valued Clients and Friends,
This time of year (third week of March) is best associated with March Madness, which some of you may know is my favorite sporting event of the year, and which this year I saw very little of opening days (being plugged away in Washington DC), but which I hope to catch much more of back in my apartment in New York City this weekend. But five years ago, there was no March Madness at all, though what we were experiencing in real-time and certainly would come to experience in the months that followed (longer for many) could be described as madness. The history of the experience that was March of 2020 will be the subject of today’s Dividend Cafe, not merely for the “trip down memory lane” of it all but especially for the lessons and takeaways that are most important for investors.
The truth is that the March 2020 COVID moment in markets, which reached its five-year anniversary this week, is not exclusively “in the past.” Some profoundly important aspects of that moment remain with us “in the present” and deserve our unpacking this week.
I’d rather celebrate the anniversary of various March Madness moments over the years (I could share many), and I recognize that what we as a country went through and what investors and markets went through five years ago is the furthest thing from celebratory. But the lessons are not to be forgotten, and they will be front and center this week as we jump into the Dividend Cafe…
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A Week or Two Worth Forgetting
On Sunday afternoon, March 8, 2020, I was sitting with a group of clients we were hosting at the Hoag Classic golf tournament in Newport Beach when the Sunday night futures market opened, with the Dow showing down 1,000 points and oil down over $20 per barrel (from $50 to $30) as Saudi and Russia essentially decided to flood the world with oil (not knowing, or not caring, about the severity of demand erosion that was about to take place). Our company had been a sponsor at the golf tournament, but the mood was not celebratory or even remotely social. I had a redeye flight to catch to New York City, and the next day was my first day in TBG’s new offices at the Graybar Building by Grand Central. I also had a brand new assistant starting that day. Joleen and I walked from our Central Park apartment in the Upper West Side to the new office early Monday morning before the market opened.
And then the next month or so would be a total blur. Literally.
The market would drop 2,000 points that day.
On Tuesday, March 10, I was on an Acela from New York to Washington DC bright and early (same place I am writing this Dividend Cafe from now), and there were two or three other people on the train. I sat with Larry Kudlow at the National Economic Council offices and saw several other key administration people. The mood was, shall we say, uneasy. The major takeaway was that they did not know any more than markets did (or anyone else) as to what exactly was going on.
On Wednesday night, March 11, then-President Donald Trump announced that he was suspending travel from Europe and Asia into America. It was announced that Tom Hanks had contracted coronavirus. The NBA suspended its season. And it generally felt like something was going very, very wrong. The next day, March 12 (a Thursday), the Dow dropped 2,352 points, a 10% drop that was the worst percentage drop since Black Monday of 1987. Markets were now down over 25% in one month (8,000 points on the Dow), and the general feeling of uncertainty was hard to explain. I had a lengthy dinner with John Mauldin and Rene Aninao of Corbu that night, and the general feeling was that more market volatility was coming, but the whole affair would hopefully be past us in a few weeks.
On Friday, March 13, I would appear on Maria Bartiromo’s show at Fox Business, and it would be the last time I was inside a TV studio for a long, long time. Markets made back 2,000 points as Vice President Pence announced some sort of tracking plan that gave markets some sort of feeling that maybe this thing wasn’t about to spread into chaos. It felt hopeful for a moment in markets, but as I walked home that afternoon and saw the emptiest midtown Manhattan I had ever seen, I called my wife and said, “we ought to fly back to Newport tonight.” We arrived back on the West Coast at 3:00 in the morning, intending to ride out a two-week spring break that our kids had from school and then return to NYC by the end of March.
We would end up returning in June.
Sunday night, I got a call from a client who had written naked options at another firm and was getting margin-called out of his mind. That call will forever stick with me as a defining moment of the fear and chaos we were in (we obviously don’t write naked options, or any options, or anything naked, at TBG, but my point was that the general feeling was reaching 2008 level of melancholy, and that was a whole different experience of trauma).
The next week would become much, much worse. The market dropped 3,000 points (-13%) on Monday, March 16, breaking a record set two days earlier for the worst day since 1987. Tuesday was up 1,000 points. Wednesday, down over 1,000. Friday down another 1,000. And at this point, I actually think that, at some point, the daily market volatility became less and less of a concern. The daily death toll was become unfathomable in New York City, particularly at nursing homes, and talks of mandatory lockdowns around the country were becoming more and more pronounced.
While all of this plays out daily in markets, the Fed had brought rates down to 0% and announced trillions of dollars of quantitative easing. Markets didn’t care (note: the cost of funds is not the deciding variable regarding borrowing funds during a global pandemic). Congress was fighting back and forth over what would be called the CARES ACT, working its way towards a legislative package to address a vast array of policy implications from what was happening (more on this below).
On Monday, March 23, two weeks to the day from that initial aforementioned “down 2,000 points” day, the market would touch 18,213 in the middle of the day. That would prove to be the bottom of this market swoon. The S&P dropped 35% in just a tad over a month. This market “bottom” came before most states had even experienced a death from COVID, before the extension of the national “sheltering in place” extension in April, before the CARES ACT and its $2 trillion of spending had even passed Congress, and obviously eight months before the vaccine got approval. Weirdly, you could say that the market swoon all took place before we really knew anything about COVID at all, and the recovery began just as all the damage from COVID was really getting started.
I could do a whole separate Dividend Cafe on all the drama of the months that followed. The equity market index bottomed on March 23, but credit spreads, CMBS spreads, obviously the unemployment data, GDP deterioration, the oil markets, and all sorts of other risk asset and economic data had barely even warmed up. March 9-23 was a two-week period, but the aftermath of the COVID moment would last a heck of a lot longer than two weeks.
National Margin Call
I believed then, wrote then, and even more now that the beginning of the market breakdown in late February and into early March was the initial uncertainty of what was happening in China. Markets were down early on, but here in the states about 49 states had not even heard the words “COVID” or “coronavirus, the topic never came up once at a late February Democrat primary debate, and there were zero documented cases in the United States. But by this March 9 period, energy markets were pricing a glut of supply going head to head with potentially collapsed demand, and that is really bad. But the evening of March 11 was the symbolic beginning of the beginning. The market began tanking because the news was really bad. By March 16, with lockdowns looming and the virus spreading, there was no clarity as to how bad this could be, and utterly absurd death projections were being tossed around. “Uncertain deaths” is generally an expression associated with “bad markets.” But then a national margin call began. The final capitulation of selling was the washing out of leveraged asset owners who became forced sellers. It was bloody, and for many, it was permanent. But it also was quick. And as these levered, forced sellers were margined out of risk positions, the market took it hard, violently, and quickly, and then it ended.
Caring about the Cares Act
On March 25, Congress passed what would become $2 trillion of spending from the Cares Act, which was passed with basic bipartisan support and pushed heavily by the Trump administration. A famous component of this would be the so-called Paycheck Protection Act, where businesses could get money quickly and then, if later could prove they sustained their payroll to some degree, would see that money forgiven. Direct payments went to households. Unemployment benefits were extended and magnified. Money was sloshing around like crazy, and the knock-on effects of this actually lasted years. It was all deficit-funded, and that mattered. But the Fed was there to help finance it …
The Fed’s Role in All of This
I could write a book on the intricacies and implications of the Fed’s activities in the COVID moment of spring 2020, and the five people who would buy it would get their money’s worth. But in the interest of time, let me offer three main takeaways that I believe to be profoundly important in how we understand and remember the COVID moment and the Federal Reserve’s role in it:
- In 2020, the use of the 2008 playbook was not controversial – it was completely, totally assumed (aggressive and “creative” asset purchases). When Ben Bernanke went to aggressive Quantitative Easing in the years that followed the financial crisis, it was unprecedented; it was hotly debated by Fed Governors (including one FOMC member by the name of Jerome Powell), and it was covered in the context of the experimental endeavor that it was. In 2020, there was not even a blink. Not from the Fed. Not from the media. Not from the public. Not from academia. Not from the markets. The only question was magnitude and composition – but a massive shock and awe use of QE was completely baked in the cake from the beginning of the COVID moment, and this alone was categorically different from 2008.
- The “creativity” of Fed asset purchases should never be underestimated now. The Fed has certain laws that limit what can be done. Let’s just say that legal scholars and financial experts who have sought to evaluate the limits of Section 13.3 regarding “unusual and exigent circumstances” are all out of their league when it comes to what the Fed can come up with out of that statute. High-yield bonds. Municipal bonds. Commercial real estate bonds. More asset-backed securities than you knew existed. An alphabet soup of facilities to buy assets using the lender of last resort capability of the Fed – and while in March 2009, the TALF (Term Asset-Backed Securities Loan Facility) was shocking for its audacity and controversy (and by the way, effectiveness in calming markets), in 2020 it went to the next level for its audacity, and a clear indicator that the Fed can and will find a way to buy anything from anyone (i.e. liquidity provider) up to the extent it deems necessary.
- The number of people who now default and turn to the Fed to save the economy and financial markets in times of crisis include, well, everyone. Yes, financial markets, and yes, politicians, and yes, the media. But in March 2020 what became abundantly clear to me was that so did the public. This was not 1998 Long Term Capital Management or even March 2009 GFC where the public either had no idea it was happening (the former) or didn’t understand (the latter) – this was just broad-based, “What is the Fed going to do?” The expectations are different now.
Now, as for #1 and #2 above, let me be very clear just so I manage to thoroughly upset and confuse everyone – always a noble aim for a writer – I have strong opinions about the propriety of both things, and those who know me as a Fed critic may expect these opinions to be overwhelmingly negative. But in fact, my opinions are far more nuanced. I would be much, much, much happier if we could just recognize that there is a trade-off to such things. “Sure, QE boosts liquidity in the financial system, but it distorts asset prices, it boosts financial engineering over productive investment, and it favors risk-takers over savers, but I think it’s worth it” – now, that conclusion may or may not be correct, but coming to that conclusion without the recognition of trade-offs scares me to no end.
What I will say is this: At this point, it does not matter what QE critics believe. There is not going to be another financial crisis or period of significant financial distress in my lifetime that impairs market liquidity and functionality, where QE is not a default play by the central bank. Period. They are going to do it. They believe it works. And because markets now believe they will do it, they have to do it. That’s the way this works.
And while I believe the Fed’s asset purchase activities were distortive, selective, and almost stunning for their audaciousness, I do believe the Fed tried not to favor them outright to privileged asset holders. I assure you many asset-backed securities investors were furious that they did not get invited to the TALF 2.0 Fed party of 2020, and that included serious insiders who made a strong case for their respective asset class. It cannot be done without cronyism, but I do not think that cronyism was intentional – I believe it is just inherent to the reality of a central bank providing liquidity to any risk asset – and therefore, it picks winners and losers, no matter how much they try not to (which again, I sincerely believe that they sincerely try to limit such). Their motivations are to avoid a systemic expansion of that which is engulfing financial markets in such periods – mainly, the inability of financial markets to function as a liquidity crisis becomes a solvency crisis. All things being equal, I do not believe it is remotely inconsistent to intellectually acknowledge these two things at once: (1) These endeavors have worked (see: 2009, 2020), and (2) These endeavors come with expensive trade-offs.
Do with that what you will, but there is a “man in the ring” component to this that keeps me from being excessively doctrinaire. I am also, though, a “first principles” guy, and interventions like this carry costs that we simply do not talk about enough.
COVID and Markets
In the March moment of five years ago, I was working 18-20 hours per day at the desk of my home office in Newport Beach, tirelessly reading, studying, calling, researching, and whatever else I felt I was supposed to do at that moment. Client calls were like a marathon, but so were calls to elected officials, doctors, economists, and anyone else in my Rolodex I could get information from. For a few days, I began assembling thoughts and takeaways on what was going on in the COVID data, the public policy side, Fed actions, and, of course, market activity. I sent these thoughts out as an email for a couple of weeks and then incubated them into what was the COVID and Markets website we started. I did this every single day, seven days a week, for six months. By September 2020, I was ready to be done talking about COVID, and we transitioned it down to a weekend-less offering, and eventually closed the COVID branding down and changed the name to DC Today (and since then, folded that into our legacy Dividend Cafe brand). This was a growth experience for me. I have been a meticulous, research-oriented guy my entire adult life, but cold-calling hospitals in Texas and New Jersey to find out what ICU surge capacity really meant was something I will never forget.
I bring up this experience because it was therapeutic for me. I learned a lot, and I tried my best to share a lot. And I am grateful for that opportunity to push myself. Things sometimes happen in mysterious ways.
The lessons I learned
As I reflect on the experience of five years ago, I believe these five takeaways represent my best summary of all I learned and what I believe to be most “evergreen” about the future. The COVID moment did not create these realities, but it illustrated them, and I believe them to be permanent revelations in my quest for greater investment wisdom.
(1) Markets are discounting mechanisms, and they will drop way quicker and more severely than you expect, and rebound way quicker than circumstances seem to warrant. This was not a new lesson in the spring of 2020. It is the testimony of history. The economic debacle in 2009 and 2010 was real. The stock market’s bottom was March 2009. The market has never waited for the economy to recover; it only requires the inevitable line of sight that it will, and then it begins pricing that when you least expect it.
(2) Tough times don’t last. Human nature does. If all investors could learn how dangerous it is to conclude in certain times of traumatic events that a certain human behavior will never be the same again, they would become better investors. The number of times I heard someone say in 2020 and thereafter that such-and-such would “never be the same” became nauseating to me after a while, in addition to being a painfully expensive lesson for many investors. Extrapolating temporary experiences and events into “new paradigms” is insane, and to help you remember this, I have made a list for the next time some kind of experience happens that threatens our memories:
- Air travel is busier now than pre-COVID.
- New York restaurants are busier now than ever.
- Las Vegas is the most crowded it has ever been, ever, by far (conventions, tourism, sports, concerts).
- High-quality shopping malls currently have the highest occupancy with the highest rents ever.
There is a way to “short” people’s imbecilic moments of melodrama—it is called “going long.”
(3) Severe distress creates severe dislocations and creates serious opportunity. But seizing that opportunity requires a contrarian impulse that very few human beings have. The only way to max-capitalize on these severe dislocations is to act in a way that is so painful at the time you are doing it, and most people simply can’t do it. Many hedge fund managers became billionaires being able to do this (I think the word is “psychopath,” but I could be wrong). Either way, I have learned through multiple events in my career that dislocations are easier talked about in hindsight than in the present tense. I take comfort in knowing that when they happen, the pain one feels is going to be temporary, but I also do not believe they are “easily buyable” events. We know they were buyable only after they are no longer buyable.
(4) Principles are something you bring to a crisis, not something you come up with during a crisis. I could direct this comment to policymakers, experts, leaders, and elected officials, and I do. And I think many people should wear their behavior in the COVID moment with shame. But I would also make this comment specifically to investors. The principles that drive portfolio construction and implementation are not to be dismissed or newly developed in times of crisis. That is the behavior of someone who lacks principles and fortitude. And that is a recipe for investing disaster.
(5) The intensity of these moments is always and forever driven by the leverage reality of our financial system. The two things to remember are that (a) It is happening to others and will end, and (b) It should not be happening to you. I wish I had set this up more artfully, but let me say it more succinctly – your mark-to-market prices get pummeled in traumatic events because of other forced sellers. You should know this is happening. AND, for the love of God, you should not be one of the forced sellers yourself.
Conclusion
It is not true that I only have five takeaways from the March 2020 moment. I learned a lot of non-investment lessons – a lot about human nature – and a lot about how much our country and culture have changed since 9/11. COVID was the furthest thing in the world from a uniting moment for our country, and the divisions it exposed have been exacerbated even more in the years that followed. Those cultural and national wounds are not investment-centric, and their healing will only come about by a lot of prayer. But what I am most grateful for when I reflect on what we went through five years ago is that it is over. It was just a God-awful few weeks in markets before what would end up being a God-awful few months in our country (and for many, even longer). I pray that we will never go through that medical, social, political, and cultural experience again – but I am quite sure we will go through a market experience like that again.
And when we do, I promise we will bring our principles to the moment. To that end, we work.
Quote of the Week
“Defense of the individual’s liberty against the encroachments of tyrannical governments is the essential theme of the history of Western civilization. The characteristic feature is its peoples’ pursuit of liberty. All the marvelous achievements of Western civilization are fruits grown on the tree of liberty.”
~ Ludwig von Mises
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This was a tough one to write, my friends. I am a hopelessly nostalgic person, but there are few events in my adult life I hated more than March 2020. I know many of you feel the same.
But like so much in our lives, there is often beauty for ashes to be found, despair replaced with joy. This is true for investors who behave well. But far more importantly, it is true for humanity.
Be well. Be safe. Be free.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
