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March 18, 2020 – BMT AND FINANCIAL MARKETS UPDATE

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  • Transcript

    Introduction:

    Welcome to the Bryn Mawr Trust Wealth Management podcast, providing commentary on what’s moving the financial markets, financial planning, and other timely business and monetary topics. Please welcome your host, Jennifer Fox, president of BMT Wealth Management.

    Jennifer Fox:

    Hello, Frank Leto shared an announcement via email earlier this week that I would like to reiterate and that is we understand that you rely on us to serve your financial and insurance needs. During the ongoing COVID-19 pandemic, BMT continues to be committed to providing accessibility and service excellence. We are open for business and available to our clients in banking, wealth management and insurance. Following the latest guidance, our offices are operating with restricted access. You may have read on our website or on our social media channels that we are serving clients by appointment and branch banking via drive through service only. As such, we’ve closed our offices to walk in traffic including a shutdown of our retirement community offices and branches without drive through capabilities. BMT employees remain available to support your needs, utilizing phone and video WebEx conferencing where we can provide continuous face to face interaction. If the service required must be in person , we can schedule an in person meeting, abiding by social distancing protocols. We will continue to keep you apprised of any changes or developments and recommend that you visit bmt.com/alerts for ongoing updates. On a more personal note, Monday was the first day for a significant majority of us working from home. We’ve had snow days before but this feels different. The sun was shining and we didn’t have to shovel. In all seriousness, I appreciate that this is new for us as a community and as an organization. At the end of the day on Monday I shared the following message with our team and I’d like to share it with you and that is, I know we are now trying to figure out where’s the right place to work in the house, how to stay focused, can I hit mute fast enough when the mailman comes and my dog start barking furiously while I’m on a call?

    Jennifer Fox:

    How do I stay connected with my clients who I know are concerned? How do I handle the fact that my kids are at home and Oh, so very bored. My parents are in the at risk group and far away and the market is volatile. Really volatile. Deep breath. When I get overwhelmed, I focused on what I know to be true. I know that this is not the first crisis we have faced. Yes, this one feels different because each one is unique but we have navigated others. We are resilient. We absorb facts, unknowns and respond by keeping our clients at the forefront. We are a team. We are kind. We help each other. We push each other and we want each other to be successful. We will get through this. My favorite poet is Dr. Maya Angelou. I find her wisdom grounding. In Alex Banayan’s book, The Third Door, the wild quest to uncover how the world’s most successful people launch their careers, he interviewed Dr. Angelou. There’s a quote from her that I think is especially appropriate even if a bit long and her quote is “what I know is that it’s going to be better. If it’s bad, it might get worse, but I know that it’s going to be better and you have to know that. There’s a country song out now, which I wish I’d written that says every storm runs out of rain. I’d make a sign of that if I were you. Put that on your writing pad. No matter how dull and seemingly unpromising life is right now it’s going to change. It’s going to be better, but you have to keep working.” This is the message that I shared with our team that this storm will run out of rain. The song that Dr. Angelou references is called Every Storm by Gary Allen.

    New Speaker:

    We continue to be committed to helping you achieve your purpose and promise. Please do not hesitate to contact your relationship team or me directly. We are here to help. Now I’d like to turn the podcast over to Jeff Mills, our chief investment officer for a market update.

    Jeff Mills:

    Okay, well thanks everyone for joining us again. You know, we want to try to communicate as much as we possibly can during these times of market dislocation and stress. There’s just so much going on every day I feel like things are changing. So we want to just be front and center to make sure that all of you have our best thinking and have our UpToDate analysis on at least how we’re looking at the current situation and how we think it might evolve over the coming weeks and months. I apologize. I am recording from home as most of us are, are, are being challenged from working in different locations. So if you hear small children screaming in the background, I feel like the sounds of the family are becoming more and more common on conference calls and other things. So I’ll do my best to get through this.

    Jeff Mills:

    And hopefully there are no issues, but I, I just want to jump right in. You know, given what has transpired over the last couple of weeks I’ve continued to try to put out notes to our team and I did reach out yesterday. So this will largely be a recap of some of the things that I’m communicating internally and I hope they prove useful to you as well. I think, you know, maybe more than anything, these notes that I’m writing and these recordings that I’m doing are more helpful for me than anyone as it really forces me to gather my thoughts at the end of some really volatile and extremely difficult and often in many ways, unprecedented days in the market. And I really do think unprecedented is the correct word to be using right now. You know, we’ve seen lots of nasty markets over the years, but I think this is one for the record books, given the speed of the decline, how persistently large the market swings are, we really just haven’t seen things like this in the past.

    Jeff Mills:

    And of course the very unusual catalyst being the challenge of the coronavirus. You know, I keep reminding myself, no matter how dire the situation, ultimately the worry always ends up exceeding the actual harm. And I think we will get to a point and hopefully soon where the collective worry, whether it’s personal or the worry in the market, actually reaches a point that is extreme relative to the actual outcome. And I do think that some of the efforts that are being taken both at the state and local government level, at the federal level to try to mitigate the spread of the virus, just try to flatten that curve so the healthcare system does not get overwhelmed. You know, I do believe they’re being taken seriously and I do think it’s going to have a very positive impact on what the ultimate outcome ends up being.

    Jeff Mills:

    But that doesn’t mean the market environment that we’ve experienced over the last couple of weeks hasn’t been painful. You know, these stock market declines hurt, I don’t care who you are, I don’t care what your time horizon is. I think human psychology is fairly consistent amid market crashes and, and let’s be clear, let’s call it what it is. This is a market crash, just given the swiftness of the move, the magnitude of the move. That’s what we’re dealing with right now. You know, there isn’t much we can do to change that visceral, genetically coded emotional response that we all have to things like this. But I think all we can do is continue to provide ourselves with perspective. You know, for me this is the most effective way to remember that all hope is by no means lost. This will pass. We are going to prevail against the virus and like I said, I do think the steps being taken to reduce its spread are working and will continue to work. Ubut just I went back over the weekend and I looked at some really simple data points to try to anchor our perspective. Uand it’s not all bad. So let me walk you through some of the analysis I did and, and hopefully it makes sense. So year-to-date, the S&P 500, the total return on the S&P 500 is negative 27% or thereabouts. It’s obviously changing very dramatically, hour by hour, but negative 27%. And in a vacuum that feels pretty bad. Uand it feels pretty bad because it is pretty bad. But once you start to pull back your lens a little bit, things slowly start to get better. For example, if we look at the Barclays US aggregate Bond Index, so using that as a proxy for the fixed income markets,uand it is a good benchmark to be using,uas a proxy for our fixed income holdings, that index is actually up 3.2% over that same period. So year to date. Now, if we assume a 70 30 portfolio, so 70% in equities, 30% in bonds, that’s a total return this year of negative 18%,ugetting better, still a bitter pill to swallow. But I included a table in the note that I sent out to our advisors yesterday and it includes additional time periods to highlight the longer term returns for the S&P 500, the Barclays US Aggregate index and a simple 70 30 portfolio. Uinterestingly, a 70 30 portfolio invested 10 years ago produced an average annual return of 8.2%. So for context, if you had $1 million that was invested 10 years ago, would’ve grown in nearly $2.2 million today. Now that’s down from a peak of $2.8 million in 2019 and anchoring to that all time high value is really what hurts the most right now.

    Jeff Mills:

    But focusing just on the equity portion of that portfolio, that’s a 9.6% average annual return for equities over the past 10 years even given what has happened over the past number of weeks and that’s still compares pretty favorably to history. So although slightly below the very long-term average annual return for us stocks of about 10 and a half percent, that dates back to 1928 the average annual return since adopting the 500 stock index in 1957 is about eight and a half percent. So even after that big market drop, like I said, we’re still ahead of the game over a 10 year period. And you know, the way we approach our client relationships with long-term planning advice, I think this perspective is incredibly important. The past few years shouldn’t change much when thinking about our retirement plans or the accumulated value in portfolios over the past decade. Overall things should still be on track.

    Jeff Mills:

    Lastly, as it relates to some of these statistics, when thinking about the future, expected returns for equities are far better now than when we were at the highs. I think that’s clear. So starting valuations have a very high correlation to the average annual return and investors should expect over the next 10 years. So the relationship is simple, average starting valuation when it’s high, that equals a lower expected return and vice versa. So investors with higher risk tolerance I think now might start considering deploying long-term capital back into the market. We can’t time the bottom and things certainly can get worse and my guess they might, but future returns in stocks look far better at these prices than they did only a few weeks ago. So I think that’s also important to keep in mind. Now I wanted to shift gears a little bit and talk about the outlook and some of the things that we’re watching most closely.

    Jeff Mills:

    So I think the critical element in this entire mess and what really will help us avoid a more dire outcome in the markets is stability in the credit market and stability in the banking system. So because of that, we’re keeping a close eye on these areas. You know, we can’t predict the valuation that investors are going to assign to stocks. And then in the near term and mid, all of this fear and the impact on earnings I think is still very unclear. But what we can do is monitor the stress in liquidity and credit for clues about some sort of more systemic and potentially longer lasting crisis. I still believe that the base case scenario for 2020 should be that the second half of the year we experience a pretty sharp rebound after what is going to amount to a very painful shock in the near term.

    Jeff Mills:

    We have gotten some data out of China and I think that gives us a little bit of a taste about what global economies have in store for them. Their industrial production numbers contracted dramatically, their retail sales numbers contracted dramatically and as dismal as all of these numbers are, I do think they’re likely to rebound as people get back to their normal lives. Looking out a number of months. And you know, even looking beyond China into the U S into places like Europe, you know, the extreme fall and retail sales and the impact on businesses that will be replicated throughout the world, and I do think it all but guarantees a global recession this year. I don’t know if that means multiple quarters of negative growth, so a technical recession or just one quarter, a very negative growth. But either way we’re going to be forced to contend with that in the near term and the market is going to try its best to price what that means for earnings.

    Jeff Mills:

    But like I said, I do think the economy ultimately recovers and maybe more quickly this time around than might be typical of a recession just given the catalyst. I, I think thinking about large ticket items that might be delayed certain spending that might be delayed I, I think it is very much just that delayed and, and not completely forgone. And I think, you know, governments globally are clearly gearing up to support the consumer and to support small businesses in their respective economies. And I do think that that’s incredibly important to bridging the gap between where we are now and the other side of this crisis. You know, in this scenario where the government does step in and it does provide the proper stimulus and the proper amount of stimulus and the federal reserve steps in and provides the market with the proper liquidity to function in the interim.

    Jeff Mills:

    I do think stocks are attractive at current levels. There be more short term volatility. That’s certainly a possibility. And volatility probably does remain elevated until we have a little bit more clarity on the timeline of the virus. And until we have a little bit more clarity on what the ultimate large scale fiscal package looks like. So as I said, a freeze up in the credit markets I think remains the biggest risk to the market and to the economy right now. You know, it could transform the recession that we’re likely to experience into something a little bit longer lasting. It would increase bankruptcies, it would increase layoffs and so on and so forth. You know, already you’ve seen companies tap their lines of credit. You’ve seen that demand for cash caused some malfunction in the treasury market. You’ve seen high yield bond spreads increase to levels that we haven’t seen in a number of years, um but we do remain far from levels that we saw in 2008.

    New Speaker:

    Uh I think one of the things that we’re watching really closely to gauge whether these markets are going to suffer a period of more acute stress is looking at something called credit default swaps in the banking sector. So think of these credit default swaps as insurance investors can buy against default. So as, as the perceived chance of default goes up, these credit default spreads start to widen. Currently bank credit default swaps, they have jumped, but they don’t point to any major solvency problems against really the systemically important money center banks. So I think that’s, that’s really important to highlight and it’s a really important thing that we’ll continue to watch. And a lot of the fed action was really geared toward making sure that this part of the market functions properly and there aren’t any liquidity issues within the plumbing of the financial system that ends up finding its way back into the main street economy.

    Jeff Mills:

    So we’re going to continue to watch that really closely. It’s really critical to make sure that financial market disruptions, like I said, don’t morph into additional economic stress. So let me move on to a couple other things before I wrap up here. One is, is just the anatomy of a crisis. You know, looking back throughout history, what tends to happen during these types of market periods? You know, we don’t often have perfect analogies, especially given what’s going on today, but I do think there is some information to be gained from what has happened in the past. I think one of the interesting things is that in a crisis, the range of beliefs expand dramatically. And I think the range is rational. You know, we, we don’t know what the ultimate outcome is going to be when uncertainty increases this much. You know, the, the, the number of possible outcomes increases exponentially.

    Jeff Mills:

    And because as we sit here today, we can’t disprove any of those outcomes, at least with, with any certainty, I think investors struggle to find a price that represents really what is the most plausible reality. And in many times, you know, the loudest voices are the ones predicting the most dire outcomes. So that can create sort of a vicious feedback loop. And I think we’re also dealing with that right now. I looked at a study from a firm called Verdad Capital. They conducted a two year study of periods of market crisis. And I do think the results are interesting. And they defined crisis periods as periods when high yield credit spreads reached or exceeded 650 basis points or six and a half percent. I think that’s a pretty good definition of market stress. Usually when spreads reach that level there are some pretty serious underlying issues that the market’s contending with.

    Jeff Mills:

    So number one, what works in equities. The first thing is that interestingly, things become a little bit more predictive in a crisis. You know, studies show looking at things like value and growth or large cap versus small cap, there’s some eight times more predictive during a crisis. And let me just use value stocks as an example. So during normal periods when high yield spreads reach that 650 basis point level value outperforms the market about 66% a month over the long-term. But when you end up in these periods, when credit spreads increase to 650 basis points or above, that percentage jumps to a staggering 91%. I think you’ve seen the same thing with small cap versus large cap and so on and so forth. So simply put, investors benefit a lot more from these really simple quantitative rules, value investing, investing in small cap stocks during periods of market stress.

    Jeff Mills:

    Another really simple example would be owning companies with positive net operating income. It sounds simple, but outside of a crisis, it turns out really not to matter that much. But during a crisis it matters a whole lot. And in my opinion, all of this does come down to investor psychology. Human nature’s really powerful. And people tend to behave consistently and uniformly when they’re scared. And people are often scared in environments exactly like the one we’re dealing with right now. Now to be sure if you look at the performance of value in small cap during this period of market stress, the that performance pattern has not played out. Value has not done well. Small cap has not done well, but I think time will ultimately tell what ends up performing best as these periods of market stress..they can last for many, many months.

    Jeff Mills:

    So let me talk about fixed income quickly. What works in bonds. This was a little bit counterintuitive to me when I first came across the information, but based on Verdad Capital’s analysis, in normal times it has really not paid to reach for yield. So they referenced the triple B space and fixed income or about 4% in today’s market. You know, at that point it usually doesn’t pay to reach for that higher yield because bankruptcy rates eat up that promised additional return. It’s really during times of stress when higher yielding assets tend to perform better you know, with these investments, bigger is better. So the size of the company is important. You want high free cash flow, you want high return on equity, but reaching for yield in times of stress actually tends to work out better. And I suppose when I think about it a little bit more, it does make sense.

    Jeff Mills:

    You know, during good times when capital is more accessible, a company offering to pay you 10% yield, they might have some real issues or real risks associated with them. You know, during periods of market stress, also buying high yield will likely perform a little bit better than equities if things deteriorate further. But if things get a little bit better, it should still offer a pretty strong return. And I know where we’re right now, we’re actively looking for opportunities in the credit space. One of the thing I would say just in terms of focusing on specific areas of the market, I do think healthcare stocks continue to be interesting just given this particular crisis. We don’t have a specific allocation or an overweight to healthcare within our broad asset allocation. But it is something that we’re taking a look at and considering we certainly do have exposure to healthcare within some of our individual equity strategies.

    Jeff Mills:

    You know, not only is firming demand, sort of, we are reawakening the healthcare stocks that really were trading at a big discount because of some of the political uncertainty surrounding them. But their typical defensive nature is going to continue to be sought after, especially during this kind of a market environment. I think, you know, inevitably you have demand for healthcare goods and services are going to be going up over the next number of weeks. So I think that’s, that’s really important when thinking about, you know, their likely revenues and the impact on, on their businesses. And you know, and very finally I think valuations are also flashing green. You know, if you look at the price to earnings ratio for healthcare stocks, still trading at a significant discount to the broad market. So I think it’s an interesting space over the next number of months. You know, very finally I just think about sentiment.

    Jeff Mills:

    I always go back to that because I do think it is so important when trying to judge where we might go over the next couple of weeks and even couple of months and thinking about the way we approach the market once the storm passes. You know, looking back at history, really the only two periods where we saw anything close to the speed of the move from, from a new all time high down to these sort of crash levels would be 1987 and 1962. And after 1987, it’s really interesting to look at how impaired investor sentiment was for years after the market recovered. There are surveys, investor intelligence does a survey, they look at the percentage of bulls versus the percentage of bears that respond to that survey. And the percentage of bulls in that weekly investor intelligence survey remain really low for years after 1987 even as the market recovered and made new highs.

    Jeff Mills:

    So I think there’s an important lesson there. And the lesson is psychologically these events of the last few weeks, they’re likely to impact behavior for a considerable period of time. And I think the challenge for us is going to be overcoming the mental obstacles that have now been put in place because of recency bias. I think this is going to stick with us for awhile. You know, we’ve worked really hard to ensure that our clients don’t fall victim to this trap. I think allowing these events that we’re currently going through to impact our investment decisions that we make in the coming years is potentially detrimental to the ultimate goal and what we’re trying to achieve. I, I know that we all saw this happen to folks after 2008 when two, three, four or five years later, people were still sitting with large amounts of cash and really missing out on the market recovery and therefore decreasing the probability that they’re able to achieve the goals that they need to achieve, whether that’s funding children’s colleges, whether that’s retirement, whatever it might be. So hopefully that commentary was helpful in some of the things that we’re looking at in the current market as we stand today. Trying to make sense of it all. But I, I do think these are some of the signposts and, and things that we’re trying to pay most attention to and really just the perspective we’re trying to take as things evolve in the, in the coming weeks. So I appreciate everyone listening. Stay safe, stay healthy and we will be in contact soon. Thanks so much.

    Closing:

    This has been a production of Bryn Mawr Trust. Copyright 2020. Visit us online at bmt.com forward slash wealth. The views expressed here in are those of Bryn Mawr Trust as of the date recorded and are subject to change without notice. Guest opinions are their own and may differ from those of Bryn Mawr Trust and its affiliates and subsidiaries. This podcast is for informational purposes only and should not be construed as a recommendation for any product or service. BMT Wealth Management provides products and services through Bryn Mawr Bank Corporation and its various affiliates and subsidiaries, which do not provide legal tax or accounting advice. Please consult your legal tax or accounting advisors to determine how this information may apply to your own situation. Investments and insurance products are not bank deposits, are not FDIC Insured, are not backed by any bank or government guarantee and may lose value. Past performance is no guarantee of future results. Insurance products not available in all States. Any third party trademarks and products or services related thereto mentioned in this podcast are for discussion purposes only. Third party trademarks mentioned in this podcast are not commercially related to or affiliated in any way with BMT products or services. Third party trademarks mentioned this podcast are not endorsed by BMT in any way. BMT may have agreements in place with third party trademark owners that would render this trademark disclaimer, not relevant.

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