The Quarter in Review | 1Q 2020
FIRST QUARTER RETURNS. Last quarter we expressed deep concern about a market correction based on stock valuations, at which time we had no thoughts about a global pandemic breaking out.
The quarter began quietly with a solid U.S. domestic economic outlook. Rarely has market performance and sentiment changed so quickly than what we observed in the first quarter of 2020. Once the reality that this virus was more than just another type of flu, the market reaction was swift, deep and negative. Through February 19th, U.S. markets were up approximately 5 percent, then abruptly experienced a 34 percent decline from peak to trough. This was the fastest time to a 30 percent or greater market correction in history. With a slight recovery, U.S. markets ended down -20.9 percent for the quarter.
International Developed and Emerging Markets also experienced significant sell-offs, down -23.2 and -23.6 percent respectively. A globally diversified portfolio of 50/50 equities and fixed income declined -10.78 percent for the period.
FIXED INCOME. Interest decreased in the US treasury market in the first quarter and the Federal Reserve cut lending rates down to almost zero percent. Intermediate-term corporate bonds declined -3.15 percent. Default concerns related to the pandemic caused panic selling in High Yield Corporate bonds, down -12.68 percent for the quarter.
ALTERNATIVE INVESTMENTS. One of the hardest hit areas was in the REIT space, as concerns over hospitality, energy and retail holdings, crushed the index down -29.52 percent. The Bloomberg Commodity Index dropped at a record pace, down -23.29 percent for the quarter. Gold and Soybean commodities were the only positive performers for the quarter, up 4.20 and 3.47 percent. Gas and Oil both dropped well over -60 percent each as fears of an unprecedented economic slowdown became very real.
SUMMARY. A phrase we like to use is “risk happens slowly and then all at once” which dramatically came to pass in the last two months. We cannot remember a time when so much business activity has come to a virtual stop. Economic activity slowed to a trickle focusing exclusively on essentials. Two of the most positive economic trends coming into the year – strong consumer confidence and record low unemployment – are now on the other side of the ledger. Unlike the banking and housing crisis of 2009, or the Technology/Dot Com Bubble of 2000 – both of which only impacted limited areas of the economy; this crisis has touched every area of the global economy.
The initial GDP reading for the first quarter of 2020 came out and showed the weakness everyone was expecting as the U.S. economy fell by 4.8 percent, and personal spending shrunk by 7.5 percent, the largest drop on record. More than 30 million Americans have filed for unemployment over the last six weeks, exceeding 15 percent of the entire labor force. The magnitude of job losses has been staggering. As outlined in the chart below, all of the employment / job gains since 1998 have been virtually wiped out, 22 years of gains wiped out in six weeks.
The government is providing extended and increased unemployment benefits, which will certainly help some. It will not provide support for the millions of self-employed individuals who have also been impacted.
The monetary and fiscal policy response has been unprecedented and highly accommodative as the government seeks to build a bridge to the other side of this crisis. Several trillion dollars have been put forward – stimulus checks, expanded unemployment benefits, small business Payroll Protection Program (PPP), Term Asset Backed Loan Securities Loan Facility (TALF), even market purchases of High Yield debt by the Federal Reserve have all been put forward to help stabilize the virus’ impact on the economy.
So many businesses have been negatively impacted through no fault of their own. However, when the government steps in to rescue everyone it ends up saving a number of “bad actors” along the way. Large businesses are all about capitalism on the way up, but when things get difficult, they too want bailed out by the government. For the last decade, airlines have used their excess capital to buy back their stock instead of shoring up their reserves. Now, as difficult financial situations arise, they find themselves thinly capitalized and needing a financial bailout.
The question remains though, can all of these actions by the Treasury and Federal Reserve prevent permanent loss of capital if people’s consumption, travel and working practices have been fundamentally altered?
We expect the data for the second quarter to show the full impact of the pandemic’s economic toll and continued deterioration in consumer confidence. A few key points to keep in mind as we all work through these difficult and challenging times:
This pandemic is something new, and the health, social and economic impacts from which are very difficult to project how long and how deep they will be.
The economic data and earnings data is going to get worse before it gets better as the first quarter results only included one month of the virus impact, whereas the second quarter will have a full three months.
The companies that do survive and come out the other side of this will be stronger, more efficient and well positioned.
Diversification continues to play a strong role in portfolios, both in equity and fixed income; quality matters.
Bear markets have happened before and they will happen again, typical bear markets last an average of 11 months. We are two months into the current bear market.
The majority of Bear Markets experience two major market declines. After the initial sell-off, the market usually realizes a recovery of 50 – 70 percent of the decline (this is where we are now); after which a second sell-off will occur retesting the market lows before an eventual recovery begins.
The cash/short term fixed income reserves incorporated into financial plans are for times like this. They enable you to continue have access to funds not impaired by the crisis while allowing your equity holdings to recover.
We spend a great deal of time assessing how best to navigate these recent developments and interesting times. We believe keeping calm is essential. We acknowledge it can be difficult right now, particularly as we are constantly inundated with alarming headlines. But it is necessary to prevent imprudent reactions that may result in the wrong actions at inappropriate times.
We greatly appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.
As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we will be happy to discuss.
Please follow this link to read the complete Quarterly Market Review | 1Q 2020.
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