The Federal Reserve delivered an unprecedented second emergency rate cut over the weekend – slashing its target range for the Fed Funds rate to 0.00-0.25%. The move was part of a package of measures – coordinated with other major central banks – to counter the economic and financial impact of the coronavirus pandemic.
The Fed has now cut rates by 150 bps this month, having made no move at January’s scheduled FOMC meeting. As well as restarting quantitative easing – planning to purchase $500 billion of Treasuries and $200 billion of mortgage-backed securities – the Fed reduced its discount rate to banks by 150 bps to 0.25%, also lengthening loan terms.
An accompanying statement said the Fed would deploy “its full range of tools to support the flow of credit.” But Chairman Jerome Powell said the current rate will be maintained “until we’re confident the economy has weathered recent events.” As the Fed pauses, financial advisors and their clients will be asking: Has it done all it can and will it be enough?
Despite central bank interventions, leading indices have seen record swings, ending last week 25-30% down on year-end levels. The Fed et al can keep the liquidity taps on and encourage lending, for example flattening the long end of the yield curve to reduce mortgage rates. But unlike 2008-9, the financial system is not the problem, meaning additional solutions are needed. “The guts of this crisis require a fiscal and healthcare response,” says Nela Richardson, investment strategist at Edward Jones.
As policy responses are formulated, advisors and investors face uncertainty over the length and depth of an inevitable economic slowdown against a backdrop of extreme market volatility. Shocks like these are why you have a diversified portfolio, says Richardson. “This is a time to display perspective,” she adds. “Investors should focus on what they can control, which is their long-term financial plans.”
“It’s time to implement your bear-market plan,” says Crook, referring to the set of pre-committed actions often agreed upon by advisors and their clients to handle shocks. “It’s good to stage that capital in, as there is a likelihood of recession and the market could well go down further,” he notes.
“There are different reactions to market shocks, with some clients wanting to retreat to cash, while others might take the opposite extreme,” adds Todd Scorzafava, partner at Eagle Rock Wealth Management. “Strong emotion is rarely a good guide to financial planning. Part of our job is to remind clients of the agreed framework, which informs asset allocation and diversification, based on risk appetite.”
Jack Manley, global market strategist at JPMorgan Asset Management, says the case for being overweight in equities has grown only more compelling. Large-cap, high-quality, dividend-yielding U.S. stocks could still be the best place to be, he observes, adding: “We’re the best house in a bad neighborhood.”
Advisors will be mindful of how a shutdown is likely to ripple across the U.S. economy. Manley warns of a severe impact on services, distinguishing between displaced consumption, such as car purchases, and destroyed consumption. If you can’t take a big spring break this year, you won’t take one twice as long next. “Hotels and malls, for example, will take a Q2 hit, but we’re not necessarily looking at a V-shaped recovery,” he says.
Many U.S. investors have blinked disbelievingly at the negative yields on European and Japanese government bonds, but recent developments have led some to ponder the role of bonds in a balanced portfolio.
“Some advisors are already being asked about moving out of fixed income into cash. After massive increases, fixed income valuations can only come down. But clients need to look at the big picture,” says Michael Turvey, senior strategist of institutional trading education at TD Ameritrade. “You don’t want to compound the damage done by the markets.”
One alternative for risk diversification, says Crook, could be accessing hedge funds and private equity through mutual funds or even exchange-traded-funds.
“Tumbling yields have meant record highs for high-quality bond prices. With rates falling further, this may be the right time to rebalance away from bonds and toward stocks in sectors that look undervalued,” adds Scorzafava.