New York, NY – “A recession is likely, yet compared to recent weeks, there are encouraging signs in policy response and market activity. We are likely now at the lower end of leverage in the financial system, and the volatility associated with this deleveraging should start to decrease.”
These are the first two of three key take-aways from a white paper authored by Scott Glasser, Co-Chief Investment Officer with ClearBridge Investments, an affiliate of Legg Mason.
The full ClearBridge white paper, “Encouraging Signs Are on the Horizon,” can be found here.
“I have been trained to look for high-quality stocks with good dividends, strong balance sheets and sustainable growth,” Glasser observed. “Now I see them available. I believe clients are going to make reasonable returns if they hold these types of stocks over time.”
Glasser believes that volatility, while decreasing, is not over, leading to his third take-away.
“This is the most oversold market in terms of investor sentiment measures since 1983,” he wrote. “It has been a monolithic asset liquidation, where the market has not differentiated between good and bad and most companies have become cheap. Many businesses will face net losses, but for most companies it will be short-lived.”
“It is a good time to focus on stocks with strong balance sheets, free cash flow generation and durable business models. Today’s volatility is ultimately an opportunity to upgrade portfolios and focus on long-term strategies.”
According to Glasser, the brunt of the damage done by the coronavirus (COVID-19) has shifted from Asia to Europe and the U.S. Financial markets have declined and become increasingly volatile. Steeply falling oil prices worsened the situation.
“The toll will be large, though there is some growing (if still early) solace in recent developments,” he wrote. “Based on the experiences of China and South Korea, with significant testing and severe restrictions on social interaction, the virus can be contained.”
No asset class or industry has been spared in the market decline. Assets across the board have seen losses on a global basis. There is no or little differentiation, within U.S. equity markets, of factors: quality, size, beta, balance sheet or dividends. Yet differentiation may still come.
“There has been an insatiable global thirst for dollars and liquidity,” Glasser wrote. “The financial system has already seen an enormous amount of deleveraging. Commodity trading accounts, volatility funds, risk parity funds and other client-oriented funds, as well as hedge funds, levered ETFs and MLPs all have de-levered in the past two weeks.”
Like all investors, Glasser and the ClearBridge team are looking for a bottom to the market. “But that is a process and not a day,” he wrote. “It will ultimately depend on news flow and our ability to get a handle on the depth and length of the crises.”
“If you look at the recessions we’ve had going back to the 1940s, from peak to trough, the markets lost 32% on average. Before the rally on March 24, we were near that 32% level. At the start of the year, markets had clearly priced in a soft landing where earnings growth was projected to return to 10% in 2020,” he said. “With the high likelihood of a recession, valuations need to come down very dramatically. This has happened to some extent.”
From social and economic perspectives, the more drastic movement and distance restrictions become – and the more seriously they are taken – the deeper the pain will be shorter term.
“I believe the shorter the duration of the recession, the quicker people can go back to work. There is evidence that these actions work. The U.S. is focused on solutions, and compared to roughly a week ago, I’m much more encouraged today.”