The strategy for Coronavirus is to “flatten the curve” by shutting down large segments of the economy, Social Distancing, and other measures. “Flatten the curve” means to lengthen the period of time of peak infection so as not to overrun our health care system and thereby reduce the number of deaths. Another name for a flatter curve (i.e., flatter than a normal distribution bell curve) is a Platykurtic curve. Think of a platypus with its flat face.

What we have in the stock market is kind of what we would potentially have in the medical system if we didn’t take these measures such as Social Distancing. There has been so much trading volume and so little liquidity available in the trading markets that we have a very steep distribution of depth of market. The high trading volume is flooding the market with orders and the market is having to adjust wildly and quickly to adapt and accommodate all of the buy and sell orders. This is why we are getting 1, 2 and even 3 thousand point swings in the Dow on a daily basis, and why a swing less than 1,000 points in the Dow one way or another now seems like a relatively calm day. Another word for a steep curve is Leptokurtic.

Causes of Leptokurtosis in the Stock Market

Sometimes the cure is worse than the disease. We had the “Great Recession” of 2008-2009, and the banking system bore a lot of the blame. In order to “cure” the abuses of these banks, and as part of the US Government bailout of several commercial and investment banks, through Dodd-Frank and the Volcker Rule, the US Government henceforward prevented banks from trading on their own account. At the same time, the Government increased banks’ capital requirements (i.e., the ratio of equity capital to total bank assets). The net result of these reforms was that it removed the greatest source of liquidity to the trading market. What replaced these big banks as sources of liquidity? Over time, hedge funds, high-frequency trading firms, and ultimately computer-based trading algorithms stepped into the void. Nice opportunity for these firms, but they have nowhere near the capital base that the Goldman Sachs’s, the JP Morgans and the Citigroup’s have. The trading markets became thinner and steeper, more reactive than proactive, and several orders of magnitude more volatile. The cure that banking regulators came up with may have prevented the last meltdown from happening again, but it created the situation that we have now. How much longer will ordinary investors, including those of us who have our retirement savings invested in market index funds, put up with this extreme level of volatility?

How to “Flatten the Trading Curve”

As Governments are trying to “Flatten the Curve” with respect to Coronavirus, the US Government, particularly the Federal Reserve, should try to “Flatten the Curve” with respect to stock trading. One way would be to keep the current high or even raise bank capital requirements while at the same time allow big banks back into the proprietary trading business. This would avail a whole bunch of new equity capital to backstop trading. Perhaps in time all of this new capital would crowd out the computer algorithms, or at least minimize their profitability so that these market swings are minimized. I advocate this deregulatory approach rather than more regulations on trading. Perhaps there are other ideas out there but I would only advocate those that allow the markets to do their job and not to burden traders with more regulations.

IMO

Platykurtic and Leptokurtic are great SAT words, which is ironic because according to collegeboard.org, the SATs are canceled through May. Our governments are trying to make the Coronavirus curve platykurtic while at the same time they are doing nothing to make the stock depth-of-market more platykurtic. Coronavirus can make you very sick, but so can this extreme volatility in the stock markets – at least it gives you severe indigestion. Desperate times call for desperate measures, and as we are trying to flatten the Coronavirus curve by shutting down major segments of the economy, we should also attempt to flatten the stock volatility curve by allowing large, well-capitalized banks back to doing what they did well for years before the do-gooders attached the strings that these banks now abide by.

The US Senate has passed a $2 Trillion Coronavirus Assistance bill. The House of Representatives is likely to debate and vote on it starting Friday 3/27. Former (now deceased) Illinois Senator Everett Dirksen once famously said, “A billion here, a billion there, pretty soon, you are talking real money.” This $2 Trillion bill makes Dirksen look like a piker. We don’t know what the final bill terms will be but let’s examine the Senate bill.

What’s In It For You?

If you work for a living, it is more likely that you will remain employed. According to this article in the Washington Post, $504 Billion will go to maintaining the payrolls of larger businesses (over 500 employees), and $377 Billion will go to small businesses for the same reason. That’s a combined total of $881 Billion, or 44% of the total $2 Trillion. If you are a small business owner, it behooves you at least to look into a loan through this program because the loan will be at 0% interest rates and can be forgiven if you maintain your payroll through June 30, 2020 (at least as I read it – read it for yourself here in the text of the bill through the Senate website.) Small business owners can apply for a loan through a bank that is also an SBA lender – many banks are SBA lenders. Loan amounts are capped at $10 million and are specifically designed to help small businesses pay their expenses during this shutdown, including payroll, rent, and other expenses. Don’t lay off employees, and you don’t have to repay the loan. What remains to be seen is whether this SBA loan will be in senior lien position to other loans that your small business may already have on its books.

If you are a taxpayer, you will get a direct payment of $1,200 per taxpayer and $500 per dependent child. Sounds good, but don’t get too excited because the direct payment amount gets reduced at incomes starting at $75,000 ($150,000 for married filing jointly) and end altogether at incomes over $90,000 ($180,000 for MFJ). This direct payment benefit is aimed at the part of the populace that could use it most: those at the lower end of the income ladder. Moreover, as I have noted before, I am skeptical that this benefit will have a significant effect because so much of the economy is shut down – bars, restaurants, entertainment venues, and many retail stores. Nevertheless, $1,200 is $1,200 and will be nice to have for many people. This $290 billion provision, together with $260 billion designed to beef up unemployment insurance, will help cash flows for people in dire straits.

There are other provisions such as some tax cuts, aid to state and local governments, and aid to hospitals and medical facilities, that bring the total up to the $2 with twelve zeroes. It is a mind-boggling amount.

Where is it Coming From?

The US Treasury will borrow this money by issuing more T-Bills, Notes, and Bonds through the usual markets. Because interest rates are so low (below 1% at maturities of 10 years or shorter), the current cost of this capital investment is good. It is a valid point to ask what we are burdening our children, grandchildren, and subsequent generations with. It is likely that this debt will be refinanced over time and never repaid. If interest rates remain this low, then it might be worth the gamble. If not, then we are committed to a lot more debt service in the future. It’s a moral question.

IMO

Though I am a proponent of small government, I am in favor of this bill, warts and all. Granted, there is pork in the bill, though we don’t yet know the extent of that pork and won’t know until the House passes its bill and the President signs it. However, this is not a crisis that these businesses large and small got themselves into as a result of poor decisions or poor management or disruptive technologies. This crisis resulted from a pandemic and our federal, state and local governments’ reactions to it, specifically the cessation of a large amount of economic activity. This is unprecedented, and so politicians are operating without a playbook. With interest rates as low as they are, I am an advocate of this program, especially if we can limit the pork.

It seems self-evident, and most economists agree, that this Covid-19 crisis is going to result in negative GDP growth in the US and worldwide. You can’t shut down large segments of the economy and issue stay at home orders without economic repercussions. Economic forecasts I have seen have ranged from negative 8% down to negative 30% GDP growth year over year from 2Q 2019 to 2Q 2020. The bulk of the forecasts are in the negative low-teens. Let that set in for a bit.

Recession?

The most common definition for a Recession is two consecutive quarters of negative GDP. Common, but not universal, as the US National Bureau of Economic Research does not fully accept the two-quarters definition. Nevertheless, for our purposes, let’s accept it. Will we have 2 quarters of negative GDP? We’ll see about Q1 2020 soon enough. Will the March air-brake halt reflect quickly enough to cause negative GDP for the entire quarter? It seems very possible to me. Assuming the Covid-19 infections flatten out and the government sounds the All Clear to continue “business as usual”, will the comeback be steep enough to pull the entire 2nd Quarter out of the nosedive and back to positive? I doubt it. What about 3Q 2020? That entails thinking about economic activity through the end of September. I think it depends on how quickly that All Clear is sounded. It isn’t looking likely to me that we will have positive GDP in the 3rd quarter, although the 2nd quarter may be so bad that any positive reading in the 3rd quarter would be a low bar to clear. My conclusion: A Recession in the standard 2 quarters definition is likely, and a Recession in the more multi-factor definition of the National Bureau of Economic Research seems to be already baked in the pie.

Depression?

The definition of Depression is more difficult to pin down. The most common definition is a Recession that lasts 2 to 3 or more years or a 10% decline in GDP. If current economic forecasts are correct and the US GDP declines by the low-teens, are we then in a Depression? Because it is “or” 10% decline and not “and” 10% decline? It seems not. The concept of a Depression implies negative GDP over a long period of time, not just a short sharp shock. Most current economic forecasts believe the economy will recover some time prior to the end of 2020. Of course, that implies that the Covid-19 risk is drastically reduced or even halted, which is a big unknown. Even though the negative 10% standard may be met, I believe most economists would still not call this a Depression because the recovery will be relatively quick. Investopedia moreover says there has been only 1 Depression in US history, that being the Great Depression of the 1930s.

IMO

On one hand, what difference does it make whether it is a Recession or a Depression? Whatever it is, it still sucks. True enough. However, we in the US have not had any type of downturn in 12 years, which is long enough that a whole generation has entered the workforce without ever having experienced anything like this. Looking at this downturn analytically and seeing how and why it meets certain definitions helps us all with some perspective on what we are currently experiencing. In so doing, it may help us understand what things might look like on the other side of this crisis. My conclusion: This is no picnic, but it probably isn’t as bad as our grandparents or great grandparents experienced during the 1930s. As you are sipping cheap wine during your self-quarantine, raise a toast to them for what they went through.

The word of today is Conserve, and it applies to several aspects of life. I mean it in the context of “make what you already have last longer.” The longer we make what we already have last, the longer we will able to make it through this current health and financial crisis and the better we will be when we come out the other side.

Toilet Paper

Our local stores have been out of toilet paper for several days. We visited stores for several days in a row but there was none to be had. We had stocked up some prior to the crisis but we were starting to run low. Nothing urgent, but it was a concern. Without getting too gross or personal, we decided to “conserve” our toilet paper use. You can take that however you would like to take it. Make what you have last longer because now we don’t know when we will be able to get more. The happy ending: Yesterday I waited in line at Costco and bought a bunch of TP. We are good to go for at least a couple of weeks now. However, we are still trying to conserve – who knows what the situation will be in a couple of weeks?

Your Current Cash

Cash is king during a crisis. Conserve it! Make it last longer by spending only on essential stuff. Because restaurants and entertainment venues are largely closed, this decision is being made for you. Probably you are working at home and so you aren’t spending as much money on gasoline, and even if you are still buying gasoline, it is less expensive now thanks to Saudi Arabia and its spat with Russia and Iran. Saving and not spending your cash isn’t necessarily good for the macroeconomy but it will be good for you and your future needs. If you are living paycheck to paycheck, this is even more important now, and we all hope that those in that situation are able to weather the storm.

Companies and Cash

Companies need to think in terms of moving from GAAP accounting to Cash accounting. The longer companies can conserve their cash, the longer they can stay in business and the longer their employees can get paid. Perhaps the Government will come to the rescue with some sort of lending program, but until they do company managers need to focus first and foremost on keeping as much cash as possible. Now is not the time for new initiatives to expand sales, especially if upfront expenditures are required for the expansion. Put growth plans on hold and hunker down. Conserve is the word!

IMO

It’s not “every man for himself” out there but it is important to take care of one’s own interest first. Just like in the announcements on flights: Affix your own air mask first before affixing others. Develop your own personal conservation plan and stick to it. Be happy with smaller-scale entertainment: Beer at the supermarket seems to be plentiful and inexpensive, so grab a case and watch a plague movie rerun on your tv. This has the added benefit of not drinking and driving. Better yet: Actually talk to your family. They say Talk is Cheap, which in this day and age is a good thing. Hold on to what you have today so that you will still have it when you might need it in the future.

I am an advocate of limited government intervention even during crises. However, I believe that this Covid-19 crisis is different and that the US Government, through the Federal Reserve and the Treasury Department, should create a credit facility so that US Businesses can borrow at favorable rates in order to tide them through this temporary period of reduced economic activity. To this end, I agree with this editorial in the Wall Street Journal.

Paycheck To Paycheck

Just as you read about workers who struggle with their own finances and live paycheck to paycheck, many small businesses live in the short term as well. Think about local restaurants that dip into tonight’s till in order to pay for tomorrow’s food order as well as for the salaries of the people who work at those restaurants. It is not in the best interest of those restaurant owners or workers to go out of business because we all need to stay home to stem the spread of a pandemic. This is not an issue of creative destruction or the evolution of tastes. Instead, much like during World War II, the nation is mobilizing (or de-mobilizing, as the case may be) in order to fight a pandemic. US Businesses and the people who work at those businesses shouldn’t be collateral damage in this war.

Rates are Low

US Treasury rates are sub-1% across the yield curve, and there doesn’t seem to be an end to the demand for US Treasury debt. Per this Wall Street Journal article, in order to create this proposed credit facility, the Federal Reserve would invoke emergency powers under Section 13(3) of the Federal Reserve Act and thereby create a “Government-Backed Credit Facility” that US businesses could access in order to keep their businesses from going under. With rates so low, we should allow US businesses access to Government rates during this time of need. If this Covid-19 crisis is indeed temporary, even 3 to 6 months temporary, it would be better to allow businesses to stay open by borrowing at the Fed window than to allow them to go out of business and then have all of those workers move to the unemployment window.

IMO

The Federal Reserve already used one bullet in its arsenal when it dropped the Fed Funds rate this past weekend by 100 basis points to near zero. It was a “nice to have” but investors were unimpressed and the Dow Jones Industrial Average declined by 3,000 points on Monday 3/16, the first day of the new zero interest rate policy. Investors were unimpressed because the rate drop addressed a potential liquidity crisis, which isn’t really what we have now. Instead, the current crisis is really a solvency crisis – can US businesses, especially those who are not capitalized enough to withstand a crisis (and who is?), make it long enough to see through this pandemic? This proposed Government-Backed Credit Facility would directly address the solvency issue, more than dropping the Fed Funds rate, and more than a fiscal stimulus budget package (although that would be nice, too). Look for something like this to happen in the relatively near future.

Wow! What a tough couple of weeks! S&P 500 down over 25% peak to trough. Oil stocks have cratered. The USO, which is the US Oil ETF, is down 50% since the beginning of 2020. Here are some of my thoughts about this current situation:

Negative GDP: I believe we are likely to have negative GDP growth. Certainly for March, possibly for the entire 1st quarter, and possibly for the 2nd quarter. Too much of the economy is on hold for there to be positive growth. “Recession” means 2 consecutive quarters of negative GDP growth, and I think that is a real possibility. As a leading economic indicator, stock prices fall as the economy is heading into a recession and recover and point the way upward as the recession bottoms out. The sell-off in stocks we have had for the past few weeks fits the bill. Don’t be shocked when the headlines after the actual data come out to say we are in a recession. Which leads to my next point:

Headline Risk: The stock market is pinballing based on headlines. More Covid-19 than expected? Bad! Sell! Federal Reserve drops rates and pumps money into the system? Good! Buy! Tax cut or other fiscal stimuli? Good! Buy! Saudi Arabia starts an oil price war? Bad! Sell! Covid-19 data is not likely to improve here in the US very soon, at least not for the next 30 days or longer. If that’s the case, I don’t see a sustained recovery in stock prices until headlines are more favorable. Like it or not, headline risk is here to stay, which leads me to my next point:

Traders Without Experience: The last 20% + correction occurred in 2008. A lot of institutional traders today weren’t active then and therefore have never been through anything like this before. Traders with experience have seen it all and are less likely to panic when the going gets tough. Traders with less experience do panic more. Panic doesn’t help.

Lack of Liquidity: After said 2008 correction, during its post-mortem, structural changes were made through Dodd-Frank, the Volcker
Rule, and other laws. The results of these changes were to alter the sources of liquidity away from the traditional banks and toward non-bank financial institutions such as hedge funds. The new liquidity sources don’t have nearly the financial resources as did large Wall Street banks. As often happens when laws change with the best of intentions, the opposite of what was intended actually occurs. The lack of liquidity in the stock market has abetted this sell-off.

Passive vs. Active: For the past several years money has moved out of actively-managed funds and toward passively-managed funds and ETFs. This is a good thing with respect to savings on costs and fees but not a good thing when faced with a sell-off. With fewer actively-managed funds, there is less money out there looking to invest at bargain-basement prices here right after a 25% correction. This is the time for bargain hunters to flock in given the 25% (or more) sale on prices, but those types of shoppers aren’t as plentiful as they used to be.

IMO

You might question why Covid-19, as relatively small as it is currently in the US is having such a telescopic effect on the entire economy. Although it sounds like an awful disease, the casualties so far are relatively few and confined mostly to the elderly. The reason is that Covid-19 causes a huge amount of uncertainty throughout the economy. Stocks trade based on a multiple of corporate earnings. Nobody knows the effect that Covid-19 will have on corporate earnings. It will certainly be substantial in the short term but perhaps not as much in the longer term. My advice: Stick to your long-term investing plan. Reallocate among asset classes if you feel the need. Most of all, don’t panic and sell now.

Today as I write this the VIX Volatility Index is a bit above 45. As you are well aware, the stock market has been extremely volatile over the past several weeks and the 45 reading on the VIX Index reflects that level of volatility. In late January, the VIX was hovering at around 12.5, as a point of reference.

What Does VIX 45 Mean?

VIX at 45 means that the market is saying there is a 68% or 1 standard deviation of a likelihood that the stock market will be either up or down by 45% over the next year. For a monthly prediction, take the square root of 45, which is 6.7, so the market believes there is a 68% likelihood that the index will go up or down by 6.7% over the next 30 days. In this environment, it seems anything is possible, and so a price change of these magnitudes is certainly not out of the question. 45% up in 12 months sounds wonderful, but 45% down does not. That’s the world we are living in now, and we need to be prepared to operate within this new world.

Don’t Panic

In my opinion, the worst thing you can do during heightened volatility is to panic. Don’t sell when everyone else is selling, and don’t buy when everyone else is buying. Be consistent with your investment plan and stay the course. Better yet, use these down days as a buying opportunity – maybe not chips all-in, but some of your chips. This volatility is largely due to the Covid-19 threat. Eventually, Covid-19 will abate or even go away and we likely will go back to business as usual.

IMO

Having a solid investment plan and sticking to it is even more important during increased volatility as we are currently having. If there is a 68% probability that the stock market will swing 45% in either direction, it will be steady, long-term investors that will bring the VIX down back to reality. Make sure you understand your own investment rules and stick to them, especially now. I know, easy to say but not so easy to do. But try to remain calm as best as you can.

With stocks selling off, investors are flocking to bonds, and US Government bonds in particular, so yields on those bonds are heading lower, and are now nearing zero. According to the US Treasury, at the close of business today (Thursday, May 5), the following are the yields on US Treasuries for certain maturities:

• 1 Month: 0.92%
• 3 Month: 0.62%
• 1 Year: 0.48%
• 2 Year: 0.59%
• 10 Year: 0.92%
• 30 Year: 1.56%

So for any maturity 10 years or sooner, a bond buyer will not even get a 1% current yield. Also, for anyone trying to decide between a 1 month and a 10-year maturity, it doesn’t matter – you will get the same yield, although, for the 10-year, the yield is locked in for that period of time. The cumulative deficit of the US Government may be $22 Trillion, but investors can’t seem to buy enough US Government debt.

Ramifications

Treasury yields at below 100 basis points and nearing zero makes alternatives more attractive. If you want total safety, invest in money market accounts, and make sure you spread your money around multiple banks if you have more than the $250,000 limit on FDIC insurance at one bank. If you want to stay in bonds but are ok with a higher risk level, look at investment grade-rated corporate or mortgage bonds, where you can earn in the mid-single digits.

Stocks Look Good

Above that, you can consider stocks, perhaps dividend-paying stocks, which look good against sub-1% Treasuries. Stock investors have been saying “TINA” (There Is No Alternative) for several years now, and it remains true today. If an investor wants to make some money in a diversified portfolio, now more than ever, they need to be invested in the stock market.

IMO

It’s still winter, meaning it is still flu season. Covid-19 originated in Wuhan, China. If you believe the statistics from there, Covid-19’s spread is ebbing there, even during winter. That is good news. The stock market has been selling off because Covid-19 seems to be spreading relatively quickly throughout the world. If the trend that has played out in Wuhan plays out in other affected areas, by 30 days from now, the news should be better. All of this argues once more for owning a diversified portfolio of equity and debt and for holding on to it for the long term. Don’t panic and stay your course.

An additional provision of the SECURE Act is that it allows 401k plans to allow annuities. You can use your 401k balance – or a part of it – to purchase an annuity that will provide a stable stream of income for the rest of your life. What could go wrong?

What Is an Annuity?

I won’t go into a long background. Read this article recently published by US News or just Google it. The SECURE Act allows all different types of annuities in 401k plans: fixed or variable, immediate or deferred.

Low Interest Rates = Low Annuity Rates

As I write this, the 10-Year US Treasury yield is about 1.3%. Interest rates are low as investors move money to safe havens as the Covid-19 threat looms. If you are considering an annuity as an option for future income, your payout rate will be a low percentage of your investment because risk-free reinvestment rates are historically low right now.

Fees Can Be High

It is said that annuities are sold, not bought. They are sold because the sales fees are high to the companies and brokers selling them to you. Fees are particularly high on variable annuities. If you are considering an annuity, whether in a 401k plan or outside it, make sure you are aware of its commission or “load” fees as well as any annual maintenance fees. Caveat emptor.

Default Risk

Another risk is that the annuity provider, typically an insurance company, goes out of business. Remember AIG back in the mid-2000s? They were and still are a major annuity provider. If you have an annuity from an insurance company that goes bankrupt, you are in a heap of trouble, and your “safe” income stream will stand a good chance of being interrupted, if not totally eliminated.

Synthetic Annuity

Do you like the idea of an annuity but don’t want to pay those fees? Talk to a financial planner, such as me. Your financial planner should be able to create an annuity stream that will mimic that which you can purchase from an insurance company, at least to some extent. The financial planner doesn’t work for free, of course, but it might be worth a conversation with them.

10-Year RMD

Another issue is that the 10-Year period of Required Minimum Withdrawals (also part of the SECURE Act) must be satisfied. Typically, a 401k owner would purchase an annuity either for themselves (single-life) or for them and their spouse (dual-life), and the annuity would end at their death. Thus, the 10-Year RMD provision probably isn’t a significant issue related to purchasing an annuity in a 401k, but you need to keep it in mind.

IMO

I am not an annuity fan but I understand their appeal especially to seniors who don’t want to have to think about their income stream anymore. This post is to alert readers to the issues related to the annuity provision in the SECURE Act, and, of course, to as you to contact me if you have further questions or if you are interested in discussing alternatives to annuity products for retirement income.