Encouraging Signs Are on the Horizon

Encouraging Signs Are on the Horizon

Volatility associated with recent deleveraging should start to dampen going forward; higher-quality companies with durable business models and good earnings visibility should weather this storm better than most.

Key Takeways
  • A recession is likely, yet compared to recent weeks, there are encouraging signs in policy response and market activity.
  • We are now likely at the lower end of leverage in the system and the volatility associated with recent deleveraging should start to dampen.
  • Higher-quality companies with durable business models and a high degree of visibility into their earnings profiles should weather this storm better than most.

The brunt of the damage done by the coronavirus (COVID-19) has shifted from Asia to Europe and the U.S. in recent weeks. Along with the westward move of this unfolding health care crisis, markets have declined and become increasingly volatile. Steeply falling oil prices have worsened the situation. The toll on those affected will be large, though there is some growing (if still early) solace in recent developments. Based on the experiences of China and South Korea, we know that with significant testing and severe restrictions on social interaction the virus can be contained. China has now reported consecutive days of no new local cases. While still a difficult situation, Italy appears to be making progress and cases may have peaked.

The current decline differs from prior ones insofar as it appears no asset class or industry has been spared. Assets across the board have seen losses on a global basis. It is somewhat frustrating to date, as there is no or little differentiation, within U.S. equity markets at least, in terms of factors: quality, size, beta, balance sheet, dividends. But this is not to say differentiation will not come.

To provide some context on the current volatility: behind the correlated selling is a liquidity event. Across the globe there has been an insatiable thirst for dollars and liquidity. 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, MLPs — you name it — have delevered in the past two weeks. We are now likely at the lower end of leverage in the financial system. The volatility associated with this deleveraging should start to decrease as we go forward.

We are trying to make a bottom, but that is a process and not a day. 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. With the high likelihood of a recession, valuations need to come down very dramatically. This has happened to some extent: the forward 12-month price-earnings ratio for the S&P 500 Index was 18.2x on December 31, 2019, and 13.9x on March 19 (Exhibit 1).

Exhibit 1: Stock Multiples Have Compressed

As of March 19, 2020. Source: ClearBridge Investments, FactSet. PE-NTM is an abbreviate for expected price/earnings ratio in next 12-months.  Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

From a social and economic perspective, the more drastic and restrictive we are in terms of movement and distance — the more seriously we take it — the deeper the pain will be shorter term, but I also believe the shorter the duration of the recession and 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.

State and federal governments are taking this seriously. Significantly, the response has been more reminiscent of 9/11 than 2008: there is less a feeling of blame and more a feeling of coming together. That’s important in terms of getting this solved.

The Fed and global central banks around the world have not only lowered rates to zero, but they’re also purchasing all types of collateral to ensure the plumbing of the financial system operates. This is unprecedented: they will basically do whatever it takes. We would like to see fixed income spreads stabilize — this is important for both the broader financial system and the equity markets.

Today’s volatility is ultimately an opportunity to upgrade portfolios and focus on long-term strategies.
Scott Glasser

Fiscal actions being taken are also unprecedented. Despite some back and forth, Congress is providing enormous resources. The talk is of extending or flattening the curve — reducing the number of immediate cases to prevent health systems from being overwhelmed. From the stock market perspective, the goal is to compress the curve, making it shorter, but deeper. The role of Congress and the enormous resources it is providing — a total of roughly $2 trillion in direct financial aid to individuals, robust unemployment insurance, loans to small and large businesses and resources to health care providers — will help us bridge a portion of the economic gap. Such measures are reminiscent of wartime measures, yet they are appropriate and encouraging.

Medicines, treatments, vaccines are coming, although they won’t come immediately. There is an unbelievable amount of time, money and intellectual power going into developing solutions, and they will be coming.

I’ve been managing portfolios for almost 30 years, and I’ve been trained to look for high-quality stocks with good dividends, strong balance sheets and sustainable growth. Now I see them available. I believe clients are going to make reasonable returns if they hold these types of stocks over time. This is no different from the long-term perspective ClearBridge takes at all times.

The volatility is not over. This is the most oversold market in terms of investor sentiment measures since 1983. 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. That is what we are doing.


Beta measures the sensitivity of an investment to the movement of its benchmark.  A beta higher than 1.0 indicates the investment has been more volatile than the benchmark and a beta of less than 1.0 indicates that the investment has been less volatile than the benchmark.

Bottom in this context refers to the process of stocks reaching a low point in the sell-off before beginning a new upward move.

A central bank is a national bank that provides financial and banking services for its country's government and commercial banking system, as well as implementing the government's monetary policy and issuing currency.

Correlation is a statistical measure of the relationship between two sets of data. When asset prices move together, they are described as positively correlated; when they move opposite to each other, the correlation is described as negative or inverse. If price movements have no relationship to each other, they are described as uncorrelated.

COVID-19 is the World Health Organization's official designation of the current coronavirus disease.

Deleveraging is when a company or individual attempts to decrease its total financial leverage. In other words, it is the reduction of debt.

An exchange traded fund (ETF) is a fund that tracks an index, but can be traded like a stock.

The federal funds rate (fed funds rate, fed funds target rate, fed rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Master limited partnership (MLP) is a limited partnership that is publicly traded on a securities exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities in certain businesses; mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction, transportation and some real estate enterprises (e.g. real estate investment trust). In practice, MLPs pay their investors through quarterly required distributions.  Failure to pay the quarterly required distributions may constitute an event of default.

Multiple is another term for P/E ratio.

The price-to-earnings (P/E) ratio, also referred to as the earnings multiple, is a stock's (or index’s) price divided by its earnings per share (or index earnings). The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead, or next 12- months (NTM).

Risk-parity funds refer to a set of rule-based investment strategies that combine stocks, bonds and other financial assets

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

A spread is the difference in yield between two different types of fixed income securities with similar but not identical characteristics, with the possible differences including creditworthiness, maturity date, or other factors.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH. Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

The aforementioned Legg Mason entities are wholly owned subsidiaries of Franklin Resources, Inc.

A Master Limited Partnership (MLP) is a specialized type of corporation that is publicly traded, but structured to have earnings flow directly to participants, without first being taxed at the corporate level. However, a portion of the MLPs distribution may be subject to current income taxes. An investor may owe applicable taxes when the MLP is sold.

Investments in MLP securities are subject to unique risks, including the risks of concentrating investments in a specific sector, changes in government regulation, and changes in tax laws. MLP distributions are not guaranteed and are subject to change based on market or other conditions.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.