Buy… with Caution

Sixteen years ago today, I was wearing a kilt, driving around Dallas, Texas, to different Irish bars in my friend’s 1954 French, open-air, firetruck. It was sort of awesome.  

There won’t be any such celebrations today, which will deprive many an Irish pub of its peak sales for the year. I might drink a pint in their honor as I consider the effects on the economy. 

I’m not a viral epidemiologist. I don’t know how mild or severe the coronavirus will be. Because it is novel, or new to humans, we don’t have natural immunity from previous exposure, so I understand it can spread almost unimpeded when people get together. But I’m paying close attention to the numbers of cases and deaths, as well as estimates of the spread, and some things look out of whack. 

The fatality rate has been reported anywhere between 1% and 4%, but we can’t know because we don’t know how many people have it. We know the number of deaths, but there’s been no randomized testing of the general society, only of those who present symptoms. Many people carry the regular flu with a range of symptoms from almost none to severe. The coronavirus is likely the same. As we add more testing, we’ll increase the denominator of the mortality rate, which will drop the overall ratio. 

The New York Times has published an infection estimate between 70 million and 140 million Americans, but it qualifies in the report that those numbers were developed in February, and that any mitigation efforts would change the forecast. It’s safe to say that we’ve engaged in mitigation efforts.  

The federal government has some decent proposals, like paid sick leave and free testing, but stopping the accrual of interest on all student loans? The largest student loans are taken out by those going to grad school, future lawyers and bankers. How does it help to give such borrowers a pass? The government could have limited the interest-free program to loans in forbearance, where the borrower is unemployed or has some other hardship. Millions of people unaffected by the virus will get a benefit at the expense of taxpayers simply because they borrowed a lot of money. That’s a slippery slope I hope we don’t travel down.  

In the financial world, things change by the minute. The Fed lowered rates to the zero bound again and, just like last week when it announced $1.5 trillion in repo operations and two weeks ago when it lowered rates, the markets fell anyway. The Fed isn’t dead, but it’s not effective in this environment and should stop trying to fight the last war.  

Investors don’t know what to expect. Will the government close the equity markets for a few days, or a week? Will the Fed make it illegal to short certain stocks, like airlines or cruise ship companies, just as they did with banks in 2009? Will we bail out some industries but not others? Will we mail checks to everyone?  

The unclear future leads to a dark assessment, and opportunity. 

I don’t know when the selloff will end, but it will end. On the risk side, consider buying an option or two on the S&P500, the Nasdaq 100 Trust (NYSE: QQQ), or a stock you like. Don’t overbuy. Each option contract represents 100 shares of the stock or index. The options are expensive right now, meaning they have large time premiums, but that’s okay. The goal is to limit losses, if they happen. By purchasing an option, you limit your downside but the upside is free to run. That sounds pretty good right now.  

In fixed income, things are a bit more clear. Buy it. I’ve mentioned closed-end funds before. I like them a lot. Typically, they borrow money to increase their holdings, which supercharges the income they throw off. We hold Blackrock Taxable Municipal Bond Trust (NYSE: BBN) in the Boom & Bust portfolio. It’s paying 5.55% even though the 30-Year U.S. Treasury trades around 1.4%.   

Investors have sold many bonds and bond funds because they’re scared, or perhaps they need liquidity. But the panic will pass, and yet the Fed will still be spending $700 billion to buy U.S. Treasury bonds and mortgage-backed bonds, which will weigh on the yield curve, and short-term rates will still be at 0.00% to 0.25%. When the smoke clears, investors earning more than 5% on high quality fixed income will be very happy.