Financial markets have had a mostly positive start to the week. Through Tuesday’s close, the S&P 500 rose 1.0%, the Nasdaq was down 0.3%, and the small cap Russell 2000 advanced 5.2%. International stocks, as represented by the MSCI ACWI Ex-USA, rose by 2.1%. Fixed income markets have continued to stabilize and experience ample liquidity due to expanded Federal Reserve bond-buying programs (more on this in the “Government Policy” section below). Many states have begun to reopen their economies gradually or have unveiled plans to do so, and these actions and plans have contributed to positive investor sentiment. Coronavirus stats will be watched closely in the coming days and weeks in those areas that do begin to reopen.
Since the current intra-year low on March 23, the S&P 500 has now rebounded approximately 31% through Tuesday’s close. This sudden increase over a fairly short period time is an example of the danger of being out of the markets. We cannot know for certain if we have reached a bottom or what type of volatility may lie ahead, but we do know that the most likely way to capture market uptick is to stay invested.
This return has surprised many. There is a Wall Street adage that is important to keep in mind, “The stock market isn’t the economy.” While we are in the midst of a recession, financial markets are forward-looking machines that discount future cash flows of individual companies. Using history as a guide, we find markets have tended to bottom 3-6 months before recessions officially end. Nobody knows for certain what is next in the current situation, and pullbacks are a natural part of both investment markets and market recoveries; however, as investors, we think it can be helpful to remember this lesson from history to avoid supposing that the recovery of the economy will correspond perfectly in time with the trajectory of the recovery of the financial markets.
Yesterday, the Federal Reserve announced that it would expand how municipalities could qualify for the $500 billion Municipal Liquidity Facility (MLF). This newly implemented COVID-19 crisis program now includes cities with a minimum of 250,000 residents and counties with a minimum of 500,000 residents (new criteria that is lower than the previous one and two million, respectively). Moreover, the Municipal Liquidity Facility can now be used to purchase securities with maturities of 36 months or shorter (a more inclusive range than the previous 24 months and shorter) to help provide more liquidity in the markets that fund municipalities’ operations and projects.
Both of these actions to increase the scope and duration of the MLF are important because they may help to quell some concerns that have arisen about the municipal bond market. The upshot of the moves is that the Fed has expanded its bond-buying policy support for municipalities. As the Fed’s own statement explains, “The new population thresholds allow substantially more entities to borrow directly from the MLF than the initial plan announced on April 9. The facility continues to provide for states, cities, and counties to use the proceeds of notes purchased by the MLF to purchase similar notes issued by, or otherwise to assist, other political subdivisions and governmental entities.”
It is important to point out that, although the question of whether states may file bankruptcy has appeared in the national media, we do not believe that bankruptcies or defaults at the state level are likely. The legal impediments are great. Currently, only municipalities, not states, may file for Chapter 9 bankruptcy protection under the U.S. Bankruptcy Code. State and federal laws, including Supreme Court rulings, would need to be changed. Any federal legislation must pass through the current House of Representatives, which seems unlikely, especially considering the Speaker is from California, which will run up substantial municipal expenses from the COVID-19 mitigation measures and health response.
Further, filing for bankruptcy is politically unpopular. There will be stresses on municipal finances because of the pandemic and its associated costs. But it is also critical for investors to realize that these stresses generally should not affect or impair their core, investment-grade municipal bond investments. The high yield muni market will be the first to feel any major pressures, and that is an area that we have typically avoided in our portfolios since late 2018. Investors in high-quality muni bonds should be encouraged by the Fed’s policy support and not fret overly about the potential for some widespread wave of state bankruptcies.
 Board of Governors of the Federal Reserve System, “Federal Reserve Board announces an expansion of the scope and duration of the Municipal Liquidity Facility,” Press Release, April, 27, 2020.
The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks or estimates in this letter are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. All indexes are unmanaged and you cannot invest directly in an index. Index returns do not include fees or expenses. Actual client portfolio returns may vary due to the timing of portfolio inception and/or client-imposed restrictions or guidelines. Actual client portfolio returns would be reduced by any applicable investment advisory fees and other expenses incurred in the management of an advisory account. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Sage Financial Group. To the extent that a reader has any questions regarding the applicability above to his/her individual situation of any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. Sage Financial Group is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Sage Financial Group’s current written disclosure statement discussing our advisory services and fees is available for review upon request.
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