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|10-Yr Treasury yield was 0.66% at the end of March and 0.63% at the end of April|
Even as the coronavirus raged on, the financial markets managed to partially rebound in April from the beating they took in March. As a result, many income-based investors, in their latest statements, have seen the bonds and bond-like instruments in their portfolios recover some of their value. However, just as I stressed that the drop in value last month was really only a paper loss, I encourage you to think of the recovery as a paper gain. That’s because these instruments continue to generate income at the same fixed dollar amount regardless of any drop or increase in value, and because they have a par value that ensures the return of your full investment if you hold them to maturity provided there is no default. I’m stressing this point again because I believe we still have another shoe to drop where the markets are concerned.
Thanks to the pandemic, by the end of April, unemployment stood at an estimated 18%, and economic shrinkage for the first quarter was reportedly almost 5%.* Now consider that unemployment during the Great Recession peaked at around 10%, and even at the height of the Depression it topped out at 25%. As for the GDP, estimates for shrinkage in the second quarter range as high as 25 to 30%, which—again—are numbers that surpass even what we saw in the Great Depression.** Now consider further that the stock market fell by 56% during the Great Recession, and lost 90% of its value during the Depression.
So why did Wall Street rally in April, with the stock market gaining back roughly two-thirds of its losses? It could be that investors were cheering the progress we made in flattening the infection curve but ignoring the true scope of the economic damage being done. I don’t believe they’ll be able to ignore it for good, which is why I say I’m convinced we still have another big shoe to drop when it comes to the stock market—a correction possibly ranging between 55 and 80%, according to market history.
The good news for our clients is that most of you have little or no money in common stocks or mutual funds, which are likely to be hit hardest when and if that next big down-wave occurs. Even if you do have higher risk investments elsewhere, the April rebound means you have time to lower your risk before the next shoe drops. Remember, there’s no law saying you can’t buy into the market at another time if you take money out now. You don’t have to ride it all the way to the bottom in order to ride it back to the top.
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
There were no swaps in the month of April.
*“Millions of Layoffs Set to Push Unemployment Rate to Highest Level Since Great Depression,” MarketWatch, May 4, 2020
**“Worst Economy in a Decade. What’s Next? Worst in Our Lifetime,’ New York Times, April 29, 2020
Note: The above trades were recent block trades and do not reflect all trades done on an individual specific basis. Sound Income Strategies, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not an indication of future results. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.
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