Economists and analysts are updating their economic forecasts with the first hard data from the effects of the global fight against the coronavirus.
To say that the numbers are grim would be an understatement.
UBS estimates a 10% decline in Q2 US GDP.
Bank of America estimates a 12% Q2 contraction, worse than the 1958 single-quarter record of -10%.
Deutsche Bank exected -12.9% GDP growth in Q2 and -10% growth for the entire world.
JPMorgan expects -14% GDP growth and unemployment to rise to 6.3% by mid-year and falling to 5.3% by the end of the year, due to the pandemic passing and unprecedented fiscal and monetary stimulus.
Perhaps most frightening of all is Goldman Sach's revised economic forecast, which estimates -24% GDP growth. That's similar to Moody's estimate of about -21%, should the current status quo continue for a full quarter.
The firm expects that after April that drag on the economy will gradually fade by about 10% per month... The firm expects the unemployment rate to increase to 9% from 3.5% over the next couple of quarters." - Business Insider
But as grim as these forecasts are, there are reasons for long-term optimism.
Look at how China, the first nation to lock down in order to stop this virus, is expected to recover rapidly. After a 26% GDP slam in Q1, Deutsche Bank's economists expect a 34% GDP surge in Q2.
Still, while a recession is inevitable and will be painful, the US economy should be able to rebound in the second half of 2020, according to the note. UBS said it thinks the social distancing directive that began in March will likely cease by July, at which point a modest recovery will begin - the firm is forecasting growth over 2%.
By the end of the year, growth should bounce back to about 7% as businesses return to stable footing, according to UBS." -Business Insider (emphasis added)
These same economists expect the crisis to largely have passed by July and Q4 growth to be a rather impressive 7%.
That's courtesy of $1.7 trillion in global stimulus that has already been announced, and that likely will end up being far more. The Fed has pledged at least $5.7 trillion in support, across every tool it has, to keep credit markets liquid and avert another financial crisis.
Are we headed for another Great Depression? Nobel laureate Robert Shiller doesn't think so and neither do I, based on the best available data we have right now.
What about concerns that the virus will become endemic and never stop circulating among humans? That it could keep coming back and result in a permanent global depression?
Vaccines take 12 to 18 months to develop because, as Dr. Mike Ryan, executive director of WHO’s emergencies program explains “We have to be very, very, very careful in developing any product that we’re going to inject into potentially most of the world’s population.”
The race for a vaccine is not about stopping the current pandemic, it's about having a way of preventing this from happening again.
The flu is endemic and comes back each year. About 650,000 people die each year, and billions are infected (most never develop symptoms). Yet the reason this pandemic is so frightening is precisely that it's the first one that has brought the global economy to a screeching halt.
Once we have an effective vaccine, the probability of another such black swan will be relatively remote, though I'm sure that future viral outbreaks will create plenty of market fear and volatility.
Just as the Financial Crisis resulted in the long-term scaring of most investors, so too will the ghosts of this pandemic haunt the nightmares of many people on Wall Street for years to come.
I believe in only being as concerned as the facts say is prudent, and never panicking. A properly designed portfolio can withstand even black swan events like this.
I want to reiterate that we, as a nation, and a planet, are all this his together.
At times like these, it's more important than ever to come together, and realize that this is World War 3 against the COVID-19 Virus, and we must all think, act and come together in a wartime mentality.
The reaction of a London worker at the time paints the picture for you:
In the midst of the Blitz, a middle-aged laborer in a button-factory was asked if he wanted to be evacuated to the countryside. He had been bombed out of his house twice. But each time he and his wife had been fine. He refused. “What, and miss all this?” he exclaimed. “Not for all the gold in China! There’s never been nothing like it! Never! And never will be again.”
I have faith that the human spirit will get us through this. We have survived worse than this.
We are also prone to be afraid of being afraid, and the conquering of fear produces exhilaration.…
I have confidence in the power of the human spirit to help us get through this and come out stronger on the other side of this." - Ben Carlson, Ritholtz Wealth Management (emphasis original)
Bank of America Merrill Lynch anticipates something like 3.5 million American jobs lost by the end of the 2nd quarter and a doubling of the unemployment rate. We have no control over that. We only have control over our response to it." - Joshua Brown, CEO Ritholtz Wealth Management
I consider Mr. Brown's rally cry to his firm's clients and employees to be precisely the right mindset we all need to take right now. It's the exact mindset that I and all the Dividend Kings have right now, an "all hands on deck, wartime footing."
We can help people and people need help. We're not going to sit back, we're not going to relent, we're not going to stop. Work at home conditions, shelter in place conditions are not going to stop us from delivering the help that people are asking for and need." - Michael Batnick, Ritholtz Wealth Management (emphasis added)
So let's take a moment to come together and appreciate all the unsung heroes of this pandemic, who are essential to our country's functioning and who are being impacted the most.
Are there causes for concern right now? You bet. Specifically, rapidly rising financial stress in global credit markets.
During normal recessions, the St. Louis Financial Stress Index (0=average stress since 1993) generally hovers around 1.
The BBB-risk premium (the spread between BBB bond yields and 10-Year US Treasuries) is between 3% and 4% during normal recessions.
Corporate borrowing costs are rising rapidly, with junk bond rated companies finding themselves in a liquidity crunch.
But note how A-rated bond yields, while also rising, are much lower and rising less quickly.
In a crisis, bond investors only want to lend to those who need it least, the strongest companies in the world. Such is the nature of severe recessions.
I'm monitoring the credit markets closely and have a plan for updating the Dividend Kings' Master List to account for this rising credit risk.
I have a plan, for which I've included a new column into the Master List, as well as a list of "Fallen Angels". Those are companies whose dividends have become unsafe, or have been cut, but whose long-term thesis is still intact, once the crisis is over. Fallen Angels are a "hold" unless fundamentals deteriorate to the point that bankruptcy risk is high enough to warrant a sell.
As economic, credit market and company fundamentals change, I'll be updating the Master List and all specialty lists each week, to ensure our members have the best possible data with which to navigate this unprecedented crisis.
But this brings me to the topic of this article, which is managing your portfolio during a period of crashing economic and corporate fundamentals.
Due to the unprecedented nature of this recession, which has the potential to be relatively short but also extremely severe, I want to focus this month's best aristocrats screening article on safety through important quality metrics.
First, let's see how all the aristocrats/champions look in total.
If you were to buy all of the aristocrats and champions you'd probably do very well over the long-term.
BUT in today's historical economic times, with credit markets tightening and economists forecasting potentially the worst recession since WWII, let's dial up the quality to 11.
What are the average quality metrics for these 12 remaining aristocrats?
These 12 companies are the best dividend aristocrats for a deep recession. That's not just my assessment but based on the works of Graham, Greenblatt and S&P.
Companies that achieve a high return on capital are likely to have a special advantage of some kind. That special advantage keeps competitors from destroying the ability to earn above-average profits." - Joel Greenblatt
These 12 companies are higher quality than 91% of their industry peers, meaning they represent wide moat tightens most likely to survive even a severe recession like this one.
Over the past 30 years, less than 3% of A+ rated companies have defaulted on their bonds. (Source: S&P)
Fears of debt defaults could make things very tough for lower credit quality companies if this contraction lasts longer than the one or two quarters currently expected by most economists.
What's more, during this bear market credit quality has been closely correlated with stock returns.
These 12 companies have long-term average volatility of 19%, which is 10% and 13% less than official aristocrats and all champions, respectively.
What about sector diversification, which is an important component of prudent risk management?
While buying all 12 in equal amounts would be a bit healthcare heavy, I'll show in a minute how you can create a balanced and properly risk managed sleep well at night, or SWAN portfolio with these 12 companies.
What are these companies that conservative income investors can trust with their long-term discretionary savings (money you won't need for 3-5 years at least) during this recession?
Here they are sorted by most to least undervalued.
(Source: Dividend Kings Valuation Tool) green = potentially good buy or better, blue = reasonable buy
Notice how I have "buy in stages" on the cyclical and economically sensitive companies. By no means am I saying the CAT, GD, ADP, or ITW are at their bottoms.
Neither necessarily are the seven defensive stocks.
In any given downturn anything can happen. CAT has slightly outperformed the broader market and most aristocrats. JNJ has been the most defensive, but even Pepsi has fallen 23%.
ADP, understandably, has been hard hit, because of the massive wave of layoffs that are coming.
I never advocate any form of market timing, such as attempting to go "all in" at some estimated market bottom. Rather I advocate buying in stages, such as the Motley Fool's rule of thirds.
But first, let me show you exactly why these 12 dividend aristocrats represent such potentially attractive long-term buys. We've already seen their quality/safety metrics, but here are the rest of their stats.
(Source: F.A.S.T Graphs, FactSet Research)
These 12 dividend aristocrats are unquestionably higher quality than the broader market, as shown by objective fundamental metrics. Yet they also have slightly superior long-term return potential.
12 Best Aristocrats Since 2004 - Annual Rebalancing
(Source: Portfolio Visualizer)
These companies have managed to outperform the S&P 500 by 2.5% per year since 2004 while doing so with 1% less annual volatility resulting in a reward/risk ratio that was 44% better than an index fund.
But I know what you're probably thinking. "Are you crazy! Stocks are going to fall off a cliff, it's pure insanity to buy any stocks at all right now!".
12 Best Aristocrats Peak Declines Since 2004
(Source: Portfolio Visualizer)
It's certainly true that an all-stock portfolio can, and will fall significantly in a recessionary bear market.
But this is where proper asset allocation and risk-management comes into play.
NO DIVIDEND STOCK IS A BOND ALTERNATIVE. The fact is that if the market falls lower, these 12 companies, while likely to maintain and grow their dividends (at a slower rate naturally), are likely to fall lower.
Let me show you what I mean by a diversified and prudently risk-managed portfolio. Given the current credit conditions, and the potential for asset correlation to approach 1, let's be very conservative and use the following asset allocation
The purpose the 25% cash allocation is to provide you several years worth of living expenses, to ride out this bear market.
The average bear market lasts about three years, measured from peak to peak. The recovery period averages 15 months.
Cash is what you can spend to fund expenses during such times. What if this turns into a 40+% crash, which can take almost six years for stocks to recover from? That's where the 25% long-bond allocation comes in.
First, you spend down your cash, then you sell bonds. Never should you need to sell quality stocks bought at reasonable or attractive valuations?
Bonds can provide dry powder to rebalance into the stock market or pay for current expenses when the stock market inevitably goes through a nasty downturn. " - Ben Carlson, Ritholtz Wealth Management, (Emphasis added)
As the saying goes, "stocks let us eat well. Bonds let us sleep well".
12 Best Aristocrats Balanced Portfolio-Annual Rebalancing
(Source: Portfolio Visualizer)
Now 50 stocks/50 cash& bonds is a VERY conservative allocation. The reason I'm using it is that the goal is to deploy the excess cash/bonds into these stocks should they fall lower.
However, as you can see, even if you had bought this balanced portfolio near the market peak before the Great Recession, you would have enjoyed nearly 50% lower peak declines, just -17% compared to -31% for a standard balanced portfolio.
Yet thanks to the market-beating power of these aristocrats, you'd have still outperformed a 60/40 portfolio, by nearly 1% annually. But with 2.2% annual lower volatility and thus a reward/risk ratio (excess total returns/negative volatility = Sortino Ratio) that was 51% better.
(Source: Portfolio Visualizer)
Not only did this conservative balanced portfolio fall significantly less during precisely the kind of market crash so many now fear is coming, it was a very low volatility asset choice during normal economic times, never falling so much as 5%.
Talk about sleeping well at night!
Obviously past performance doesn't guarantee future results. All it can tell us is what usually happens in periods of similar fundamentals. This recession will likely be unprecedented, thus the cause for so much investor angst right now.
While there are no 100% certainties on Wall Street, the best any of us can do is make high probability/low-risk decisions with our hard-earned savings.
In fact, the probability of making money in the long-term is likely far higher, from these starting valuations.
The Bigger The Decline The Higher The Future Returns
(Source: Michael Batnick)
With the market down about 32% from its peak, the average 12 month returns data from 1945 indicates we might be up about 14% a year from now.
Or we might be a lot higher, given the average 12 month forward returns for periods when volatility was 40+ since 1990.
We simply don't know how this recession will unfold, when it will end, and how long the effects on economic growth and corporate profits will last.
And with the VIX currently at 75, now seems like a better time to buy stocks than almost any other. As Baron Rothschild once said:
"The time to buy is when there’s blood in the streets."
If you have cash to buy stocks now and you won’t buy, when will you? What’s your plan?
If you are afraid of losing money, then why are you even considering stocks at all?"- Nick Maggiulli (emphasis original)
But as Nick Maggiulli, a data scientist for Ritholtz Wealth Managment points out, the odds are so in your favor right now, that it is reasonable and prudent to start buying top quality companies right now.
Our nation, and the world, will get past COVID-19. It may be a quarter from hell, or perhaps even a few quarters. But America has survived tragedies in the past, including the 1918 Spanish flu, which occurred during WWI and is estimated to have killed between 17 million and 100 people globally.
While the next few months are going to suck for most people, focus on what matters.
Financially focus on riding out this economic storm in a SWAN portfolio that has the best probability of generating safe and growing income, as well as compounding your wealth over time.
The reason for these articles is to provide you with frequent and fact-based updates about this pandemic and our current recession, but also to bring hope to those that might be running out of it.
So allow me to leave you with the words of Joshua Brown, CEO of Ritholtz Wealth Management, and who has decades of experience in asset management.
I'm proud to stand side by side with Mr. Brown, in calling for unity, determination and a relentless resolve to not participate in this recession, or the panic that it could understandably induce is so many people.
The economic news about the US economy was not getting better at the end of the financial crisis. But stocks stopped going down every time that bad news hit. It took a lot of pain to get to that point, but eventually, bad news fatigue had set in. This happened with regard to potential terror threats in the wake of 2001. It happened during the Asian currency crisis of 1998. It happened during the Latin American defaults of the same era. It happened during the Ebola scare of 2014. It will happen now.
We are not going to have a 75 Vix for six straight months.
If we know one thing for sure, it is this." - Joshua Brown, emphasis added
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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This article was written by
Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.
The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).
I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.
My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.
With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.
Disclosure: I am/we are long GD, CAT, ITW, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Dividend Kings owns GD, CAT, ITW, JNJ, and CL in our portfolios.