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Darrell Cronk
Financial Health
March 18, 2020

Ask an advisor: Navigating volatility in a time of crisis

Wells Fargo Investment Institute President Darrell Cronk shares his thoughts for managing investments amid the uncertainty surrounding the COVID-19 outbreak.

Editor’s note: Darrell Cronk is the president of Wells Fargo Investment Institute, which provides investment advice to help investors manage risk and succeed financially. Cronk shares his insights for investors given the recent market volatility related to the COVID-19 outbreak and recent drop in oil prices due to a breakdown of discussions at the Organization of the Petroleum Exporting Countries, or OPEC.

Given the tremendous amount of uncertainty and volatility investors are facing, what advice do you have for them?

First and foremost, stay disciplined and don’t let emotions drive long-term investment plans or portfolio decisions. Now is a time to take control and manage the risk. Market volatility can create opportunities, but we recommend investors stay up in quality within portfolios. That means look for strong balance sheets, good franchises, and companies and sectors that are more insulated from economic highs and lows. I’d also remind investors that cash has a place in every portfolio and can help provide optionality during volatile times.

What are the factors that make the situation surrounding COVID-19 so potentially disruptive to the economy?

COVID-19 is a biological pandemic that requires coordinated public health, monetary, and fiscal responses to both contain the virus spread and also react to the economic slowdown. It has created a somewhat unique economic shock as it simultaneously disrupts global production with factories and supply chains shutting down, and a demand shock as consumers retrench and reduce spending, travel, and consumption. This dual supply and demand shock can be quickly disruptive to the domestic and global economy.

Do you think that the probability of a U.S. recession has increased due to the economic impact of COVID-19?

Yes, we believe it likely that both the U.S. and the global economy experiences a short but deep recession as economic activity comes to a standstill. Many of the world’s largest economies were weakening or already in recession to start the year — before the virus began to spread globally. 

The key outlook issue is not whether this shock triggers the technical definition of a recession, but whether this dual COVID-19 and oil-shock dynamic turn into a more traditional and protracted downturn. On average, across equities, credit, bonds, and commodities, markets are pricing high odds of a recession occurring, although we believe this could be a short contraction, lasting only one or two quarters. The long-term average of U.S. recessions is four quarters, with some as short as three and others as long as eight quarters.

“First and foremost, stay disciplined and don’t let emotions drive long-term investment plans or portfolio decisions. Now is a time to take control and manage the risk.” — Darrell Cronk

How will this impact specific sectors, like airlines, hospitality, and health care?

Airlines and hospitality are two of the most economically sensitive sectors, so as business conferences, family vacations, and sports events are canceled, these industries will directly feel it in their financials. Health care will likely have a more mixed impact as some companies, like biotechnology or larger pharmaceuticals, will scramble to help the world find vaccines and treatments that can increase business activity. Others, like hospitals or managed care facilities, may be more challenged to deal with an onslaught of patients needing care.

Cheaper oil prices would normally be seen as a positive for the consumer — is it different this time around?

I wouldn’t describe it as different this time. Consumers will ultimately benefit from cheaper gas prices at the pump and home heating costs as oil prices fall. Don’t forget falling interest rates also benefit consumers through lower mortgage rates. However, the level that oil prices have settled in at following their most recent correction will hurt U.S. oil and gas producing companies, likely causing them to have to slow or stop some of their production. This could impact consumers whose jobs or livelihood is closely connected to states or parts of our country that are large oil producing basins.

What asset classes are normally seen as more defensive in times like these?

Assets that are generally deemed more defensive during turbulent times include gold, bonds, and cash. Within equities, certain sectors are often more defensive as well, such as utilities, real estate investment trusts, or REITs, health care, and consumer staples, to name a few. I would offer a word of caution: I realize it is human nature to want to become more defensive following large bouts of volatility and a sell-off. However, this may be the exact wrong time to turn defensive as asset prices have already adjusted and investors only find themselves buying high and selling low, which is exactly the wrong strategy for any investor.

“We watch very closely the trends in consumer and business confidence levels, the strength and health of the labor market, consumer spending levels, capital spending trends by businesses, corporate earnings growth, and the level and direction of interest rates.” — Darrell Cronk

What impact do you believe that the Federal Reserve rate cut and quantitative easing move will have?

The Federal Open Market Committee announced on Sunday, March 15, that it will cut the federal funds rate by 100 basis points (1.00%) to 0.00% – 0.25%. The Fed also announced that it will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion. The Fed is also coordinating additional liquidity actions with other global central banks.

These actions by the Fed are significant and should support financial market liquidity. By taking these actions, the Fed now has fewer tools to further respond to financial stress in the future, if needed. While these actions are necessary to help financial market liquidity, we believe that additional fiscal actions would be most beneficial to help support the economy going forward.

Beyond the stock market, what indicators should investors be looking at to gauge the overall health of the economy?

There are many indicators to watch for the overall health of the economy. We watch very closely the trends in consumer and business confidence levels, the strength and health of the labor market, consumer spending levels, capital spending trends by businesses, corporate earnings growth, and the level and direction of interest rates. All of these can give you a good read on the health and growth of the U.S. economy.

What signs should investors be looking for that might indicate a turn in markets and economic activity?

Markets will be watching for three things. One, signs that the COVID-19 case growth has peaked or perhaps a vaccine is developed. Two, for a monetary and fiscal response proportionate enough to help offset the economic growth slowdown. Three, a point where valuations begin to fully discount the slowdown in earnings and economic growth. When these three conditions, or a combination of them is met, I think you will find markets stabilizing.

“Our U.S. economy is quite resilient and arguably the strongest economic engine in the world. I do have confidence that it will recover following the COVID-19 impact. If history is any guide, often there is a resurgence of pent-up economic activity following the slowdown.” — Darrell Cronk

Do you think the economy will be able to bounce back quickly after the risks from COVID-19 subside?

Our U.S. economy is quite resilient and arguably the strongest economic engine in the world. I do have confidence that it will recover following the COVID-19 impact. If history is any guide, often there is a resurgence of pent-up economic activity following the slowdown. Meaning, for a period of time, we may actually see above-trend growth following the slowdown.

Many people have seen the value of their 401(k) accounts affected during the recent stock market drop. How should investors think about their portfolios that have taken a hit?

There are advantages to 401(k) plans that I firmly believe are a way people can take control of saving for their own retirement. That said, ensuring investors have the right allocation mix of investments based upon their timeframe to retirement is imperative. For example, in a well-balanced diversified portfolio, bonds have performed well during the latest bout of market volatility even as equities have struggled. Disciplined investors will frequently rebalance their portfolios as these opportunities present themselves. If investors have more than five years until retirement, they may want to consider adding money into equities at these lower levels as we do have confidence that markets will recover following the COVID-19 volatility.


Risk Considerations

Diversification cannot eliminate the risk of fluctuating prices and uncertain returns. Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation, and other risks. Prices tend to be inversely affected by changes in interest rates. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investing in a volatile and uncertain commodities market may cause a portfolio to rapidly increase or decrease in value which may result in greater share price volatility. Real estate has special risks including the possible illiquidity of underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.

U.S. government securities are backed by the full faith and credit of the federal government as to payment of principal and interest. Unlike U.S. government securities, agency securities carry the implicit guarantee of the U.S. government but are not direct obligations. Payment of principal and interest is solely the obligation of the issuer. If sold prior to maturity, both types of debt securities are subject to market risk.

General Disclosures

Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

Opinions represent WFII’s opinion as of the date of this release and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. WFII does not undertake to advise you of any change in its opinions or the information contained in this release. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold, or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs, and investment time horizon.

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