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Weekly Market Update for April 10, 2020

by Jim Ulland

You probably remember the Dinah Washington song, “What a Difference a Day Makes.”  The four days of this week sure did that. Preferred stock had a breathtaking rebound and the S&P 500 was up over 12%, the biggest gain since 1974.  Our portfolios reflected these gains. The enthusiasm was triggered by investors feeling that progress was being made on Covid 19 and that the country would be back to work, at least mostly by May 1st. In Minnesota, 80% of the jobs can either be done remotely or have been deemed essential. The economic prospects were boosted by the passage of huge government programs to help people pay their rent and other obligations as well as to reduce layoffs and bankruptcies from certain distressed firms like restaurants, airlines, small business, and those working independently. There have to be jobs to return to for those on unemployment

The first quarter was a reminder about how harsh markets can be and the patience required to manage through these stressful periods. The equity market was down about 20% depending on index choice as shortly ago as April 1st.  During the first quarter our equity strategies were down a little less than the market in most portfolios.  Preferred stocks were down less than equities but more than we expected. Why did this variance occur and what do we expect for the rest of the year.

Almost all of the market stress in the first quarter came from the rapid onset of Covid 19, which had no vaccine or treatment.  Such a fear emerged in the equity markets, that there was a strong move to cash by investors who sold virtually anything that was publicly traded including fixed income.  The selling pressure was intense, complicated by the fact there were few buyers. One desk told Nat that there were 50 sellers for every buyer. Liquidity was tight and bid/asked spreads were wide. Our strategy during this  period was to look for mispricing and take advantage of distressed situations. With interest rates trending down, we also repositioned out of some floating rate securities into fixed rate. 

Ten days ago, after a couple days of better liquidity, the European bank regulators forced European banks to suspend their common stock dividends but not the dividends on preferreds. We have no European bank common stocks or preferred stocks in our portfolios.  However, this regulatory move raised concern that the US banks might confront the same restriction as a capital preserving measure. Thus, US bank securities including preferreds had another substantial drop. Our view at that point was it was unlikely for US regulators to stop US bank common stock dividends and that it was exceedingly unlikely they would force preferred dividends to pause, which would raise unnecessary and unfounded concerns about bank liquidity/solvency. Part of our reasoning was that US banks already had agreed to stop stock buy-backs which comprise 70% of the total return of capital to shareholders, only 30% is from dividends.

This week liquidity returned to the preferred markets and prices rose dramatically.  What triggered this was the fact that the yield on preferred had become about ten times higher than the yield on the 10 Yr. Treasury, .65% vs 6.5%. Less volatililty as shown by the decline in the VIX volatility index also helped. When Fed Chair Powell was asked Thursday about forcing the banks to eliminate their common stock dividend, he said, “I don’t think that is something that needs to be done…not appropriate at this time.”  Preferred stock dividends are paid before common stock dividends, so as long as banks have common stock dividends, they must pay the preferred stock dividends first. Preferreds moved higher on his remarks. We feel investors will continue to move funds from cash and government bond into preferreds to take advantage of the 9-10 times higher yield.

Our goal is to have portfolios close to even by year-end, but it is likely to be a bumpy road getting there.

*The information contained in this commentary is not investment advice for any person. It is presented only for informational purposes to assist in explaining factors that may have had an impact in the past or may have an impact in the future on client portfolios or composites. All expressions of opinion reflect the judgment of the firm on this date and are subject to change. Included information has been obtained from sources considered reliable, but we do not guarantee that the foregoing materials are accurate or complete. Clients or prospective clients should contact Ulland Investment Advisors for individualized information prior to deciding to participate in any portfolio or making any investment decision. Ulland Investment Advisors does not provide tax advice. All clients are strongly urged to consult with their tax advisors regarding any potential investment. Past performance does not guarantee future results; there is always a possibility of loss.