fbpx

A common analogy used for this concept is a theater – we might think there’s a lot of “liquidity” because the number of people that can fit into the general seating area, thus a lot of participants with whom to trade; however, what actually matters is the size of the exit when someone yells “fire.” And this is exactly what we just went through in the financial markets as panic-selling ensued, forcing participants quickly through that singular, narrow doorway to redeem assets for cash in an almost instantaneous fashion.

Exacerbating this problem is the fact that even high-quality, safe haven assets weren’t able to make it through the exit door unscathed (i.e. treasuries, gold, municipal bonds). We cannot overstate how disastrous this can be, and frankly was akin to the financial system plumbing stress that occurred in 2008 and 2009 during the Global Financial Crisis (“GFC”). The good news is that the Fed was able to come to the rescue in a massive scale, yet again, and this time used its full arsenal in a matter of weeks, compared to months during the GFC.  This included setting overnight rates back to essentially 0% and quickly adding massive amounts of asset purchases on the balance sheet as the Fed stepped in as the buyer of last resort for many assets that lacked liquidity. It seems to be working…for now.

The good news is that the Fed was able to come to the rescue in a massive scale, yet again, and this time used its full arsenal in a matter of weeks, compared to months during the GFC.

Additional restoration will be provided by the soon-to-be-approved $2 trillion+ fiscal stimulus. By supporting and backstopping workers and businesses, this policy can help stem the panic and the cash-grab that was occurring to keep businesses alive. Now we can breathe a little easier about solvency issues. We should also note that at this point, it would seem that low rates are here again and will be sticking around for a while.

What this means for you as investors is that essentially no asset was immune to this market shock, which is why you will see even the bond and preferred stock portion of your portfolio show value decreases (albeit, recovering somewhat at this point). While improved, this problem will not completely go away overnight – we are seeing some of the liquidity challenges calm down, but now uncertainty about the future has meant that the “clearing prices” on most recent bond sales are still lower as a marginal buyer requires a discount to compensate for the higher perceived risk until we get through this crisis.

We suggest paying little attention to what prices the most recent buyers and sellers are agreeing to – this is akin to the real estate crisis where houses in your neighborhood sold at alarmingly low levels as either the seller was distressed and/or the lack of active buyers gave large pricing advantages to a willing purchaser. When you plan to stay in your house long-term (same with bonds), these paper losses (and even gains) are really just a distraction for the investment strategy. Normal behavior will return, and what matters is that the safety of the asset and that the income streams continue as expected (i.e. a rental real estate property where the tenant continues to pay rent is similar to a bond issuer continuing to make interest payments).

We may not be out of the woods yet, but we will continue to monitor risk and take appropriate actions as necessary. While we couldn’t predict what was going to cause this crisis, we understand that crises do happen somewhat regularly – that is why we continue to stay diligent about our exposure to risk and recognize when we aren’t getting sufficiently compensated to take risk in the investment markets. Even if there are some bonds and preferred stocks that are short-term causalities during the liquidity challenges (i.e. price discounts), the important thing is that we feel comfortable knowing that the underlying issuers are sound and can fulfill their interest and repayment commitments. Furthermore, it is also important to remember that bonds and preferred stocks are senior to common stocks as it relates to a claim on the assets of the business.

While we couldn’t predict what was going to cause this crisis, we understand that crises do happen somewhat regularly – that is why we continue to stay diligent about our exposure to risk and recognize when we aren’t getting sufficiently compensated to take risk in the investment markets.

We hope all of you continue to stay safe and healthy. It is an honor to be able to serve you through the challenges of the market cycles, and we are grateful for your continued trust and confidence. As always, call or email anytime.

Sincerely,

Norris, Perné & French

Use the form below to directly submit questions or feedback:

Powered by ChronoForms - ChronoEngine.com

Step One

Step Two

We are a trusted investment advisor known for helping clients preserve their wealth and create peace of mind through active investment management, comprehensive and focused financial planning, and a tailored and coordinated service experience. We have served clients in Grand Rapids, West Michigan, and throughout the state and country since 1933.