How Deep and Wide "The Valley"?

Apr 03, 2020 | Nick Scholte


That is the question and, frankly, no one knows. But for reasons expressed herein, I believe it will be deeper and wider than consensus expectations. Economists can't model what is happening right now. My strategy is summarized.

To my clients:

First, before addressing the economic developments of the week, let me first offer a very sincere “THANK YOU” to all the health care professionals out there. I know there are at least three who receive these updates directly, and I suspect there may be more who access these updates via email forwarding from direct recipients and my website. You folks are the soldiers of this generation’s “WWII” moment, and we are relying upon you. I can’t imagine the stress, anxiety and workload you may already be under, but which is sure to get significantly worse in the weeks ahead. My family are out on our suburban front porch each evening at 7pm banging our assortment of pots and pans in our meagre show of support (my daughter prefers to use a whistle). Again THANK YOU and GOOD LUCK!

Second, I have received a number of questions via my website and directly by email (from people to whom these updates are forwarded by existing clients) about various aspects of my service. Please continue to send those inquiries directly to me. But if you are looking for a quick synopsis of my strategy to date since the onset of the coronavirus outbreak, I’d encourage you to go to the Our Blog section of my website. Simply perusing the titles and captioned comments since, say, the beginning of January, will give you a quick appreciation of what actions have been taken on behalf of clients and when. Of course you can read the full articles if interested, but the titles and capsule comments alone offer a good summary.

It was a mixed week for North American stock markets with the Canadian TSX finishing up 2.0%; the U.S. Dow Jones Index finishing down 2.7%; and the U.S. S&P 500 finishing down 2.1%.

I will go with point form yet again this week:

- It is the first week of a new month, and the usual assortment of typically important economic indicators were released: the ISM Manufacturing Index; the ISM Services Index; and the Monthly Employment Report. And guess what? These reports are of almost NO VALUE at the present time. The economic environment is changing too rapidly for these otherwise vital measures of economic activity to be timely indicators at this juncture. But, for what it is worth, the ISM Manufacturing Index declined into contractionary territory at 49.1; the ISM Services Index maintained an expansionary reading at 52.5; and the Employment Report saw the first (and implicitly, steepest) monthly loss of jobs since the 2008 Financial Crisis at a loss of 701,000 jobs for the month. ALL THREE MEASURES WILL DECLINE PRECIPITOUSLY FROM THESE LEVELS WHEN REPORTED NEXT MONTH.

- I should emphasize that I never anticipated it would be necessary at any time in my career to be dismissive of the above three measures. Readers of these update the past 12 years will know that these indicators have consistently been my favourite measures of economic health. But these are unique times. More timely than the above three indicators is the weekly jobless claims indicator reported on Thursday of every week. Last week this measure spiked by historical proportions. At 3.28 million, the weekly jobless claims measure was nearly 5X the prior high recorded in 1982, and nearly matched during the 2008 financial crisis. This week the measure doubled again to 6.6 million new claims. That’s essentially 10 million new jobless claims in just two weeks.

- Of course, none of this should be unexpected. We are in unique times dealing with a health challenge none of us has faced in our lifetimes. As I have said since early on, I am choosing to listen (or at least prioritize the opinion of) scientists over economists at this time. Every step of the way (going all the way back to January when I first began making mention of the coronavirus spreading in China) I have perceived economists to be lagging in their appreciation of the economic consequences of this pandemic. They are attempting to pencil into their models the implications of a health crisis which the models were never designed to accommodate. The NUMBER ONE economic indicator at this time will be the direction of the virus. Wild cards offsetting the viral spread are potential scientific breakthroughs that might hopefully offer a quicker conclusion to the crisis via vaccine or effective treatment than the alternative, herd immunity, might offer.

- Regarding the viral spread, I’m afraid I fall into the more pessimistic camp, but not in the way most might think. I am actually hopeful in the short term that social distancing initiatives may indeed start “flattening the curve” (there are tentative signs this may be occurring in Italy), although I absolutely believe we should have had North America wide stay at home initiatives weeks ago, rather than the ad hoc state and provincial measures taken at present. The sooner such measures are adopted, the sooner flattening of consequence can occur. But my real pessimism lies in the post-flattening phase. The fact is that humans possess no natural immunity to this virus. Anyone not infected will be susceptible. While the number of infected and the rate of new daily growth are indeed shocking, distancing measures are likely to flatten the curve and prevent some very sizable portion of the population (probably well over 50%) from being infected. So what happens then? Does the economy just “restart”. I think that is brutally naive. People will remain fearful of infection (speaking for myself, if I succeed in staying safe and healthy until the post-flattening phase, I can still see myself remaining cautious and restraining my propensity to “consume”). But I also think some variant of a “renormalization” remains the consensus once flattening occurs. The bottom line is that I think the economic challenges persist far longer than the consensus believes and, despite the truly MASSIVE amounts of fiscal and monetary stimulus, I no longer think a V-shaped recovery is likely.

- But, as emphasized the past several weeks, I DO think we get through this. I believe in human and scientific initiative. There is a global scientific push underway to find a vaccine or effective treatment. Johnson and Johnson (one of the handful of equities that I chose to continue to hold in client portfolios) announced a vaccine candidate that they have already begun testing. New vaccines such as this must go through many, many months of testing to ensure that the “cure” isn’t worse than the disease (i.e. ensuring side effects, most notably death, are not a disproportionate result). Usually, once these trials are complete and regulatory approval is granted, then production can begin. Again, it takes many, many months to ramp up production to produce enough vaccine to meet global demand. Those extra months would likely result in millions of additional deaths and untold additional economic damage. BUT, in this case, Johnson and Johnson has already begun to produce the vaccine and is ramping up production in parallel with the trial and approval process on the hope that if and when the vaccine is approved it can then be immediately deployed on a global basis since production had already occurred. This is a massive expense and a huge risk to take which would not normally occur. But extraordinary times call for extraordinary measures and cooperation, and this is but a single example. There are myriad more. Innovative and cooperative scientific thought will ultimately win out.

- Frankly, the consequences of the unprecedented speed of the current economic collapse, offset by the equally rapid and massive amounts of fiscal and monetary stimulus, make it impossible to rationally compute what comes on “the other side” (see my comments above about the inability of economists to model the effects of this outbreak). But there WILL be a “other side” (here see the immediate bullet point above). So the question becomes how deep and wide the valley in between? I’ve already argued that I think it will be both deeper and wider than consensus. But it will not be apocalyptic because human initiative will overcome. So a rational “buy program” for the very large sums of cash I have raised on behalf of clients must be put in place. Simply put, my “buy” program will be to add back select equities at specific target index levels. My current expectation (subject to change) is to institute the buy program in allotments of 1/5th of cash on hand at a time. My initial target index level is set at the lows set last Monday, March 23rd. I expect this level to be retested because I believe that as the consensus view adjusts to the longer term economic impact of the virus absent a vaccine, selling pressure will accelerate anew. Further, I intend to invest the remaining cash 1/5th at a time at progressively lower index levels (I have targets in mind here, and will communicate these as the preceding level is hit). There is no certainty such lower levels will be seen, so I must not be stubborn in my expectations. I must be willing to adjust. As communicated last week, one lesson learned from the aftermath of the 2008 financial crisis was that although I took reasonable defensive measures at that time also, I was too cautious during the initial stages of the recovery. I will work hard to avoid that misstep again. But for the sake of transparency, this paragraph summarizes my strategic thinking at this juncture.

As long-time clients will know, I can sometimes get carried away with my comments. So I will stop here. As with last week, lots of content has been left on the cutting room floor.

Take care, stay safe, and all the best,


Nick Scholte, CIM, FCSI

Vice-President & Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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