It is hard not to use the word unprecedented, over and over-again, to describe what we as humans, Americans, and investors have witnessed in just one month. COVID-19 started as a concern, and quickly morphed into a healthcare pandemic the U.S. has never seen. We have all had to make drastic changes to our daily lives to do our part in social distancing and “flattening the curve.”. These changes have had a profound and sudden impact on our lives and our economy. There is no sugar-coating the fact that April is likely to bring a rise in COVID-19 cases and deaths in more areas of the U.S. We are optimistically hearing our leading healthcare professionals, like Dr. Fauci and Dr. Gottlieb, describing glimmers of hope that the peak in cases will be late April/early May, after which we can then transition toward reopening our economy. We hope they are right.
Early in the month we ended the longest (11 year) bull market and economic expansion in history, and it ended quickly. The speed of the downturn in financial assets has been, well… unprecedented. The S&P 500 lost about a third of its value in less than 30 days, before recovering slightly to end the quarter down 19.6%.
Equity markets tend to have pendulum swings that overprice on the upside and underprice on the downside. When fear and panic overtake the markets, and in the absence of knowledge and answers, we can witness sell-offs like 2008 and March 2020. However, equity markets will recover faster than the economy can heal, as markets will positively react to a light at the end of the tunnel, rather than factual news. International names and smaller capitalized stocks fared worse than their U.S. large cap counterparts. Even uncorrelated sectors like real estate were not immune to the economic shut-down falling over 23% in the quarter.
Fixed Income Markets
During times of fear, money will be diverted to the safest haven which is short-dated government treasuries. Thus, it’s not surprising that with high demand, prices rose and yields fell (yields move inversely to prices). Yields on the 2-year treasury fell to 0.25% from year-end levels at 1.58% and the 10-year treasury bond closed the quarter at 0.67%, down from 1.88%.
Almost all parts of the fixed income market seized up for about a week in mid-March causing spreads to widen, and liquidity to dry up, which negatively affected pricing. Credit markets weren’t spared with high yield (“junk” or “below investment grade”) spreads racing up 1,000 basis points from just about 200 basis points in late February (see graph below courtesy of Merrill Lynch).
Luckily, the Federal Reserve learned from prior crises that a swift and large response was what the markets needed, and on March 16th announced a number of measures to improve liquidity and impart confidence in credit markets.
At that point, fixed income markets began to behave more rationally, especially the high-quality, short-end of the market. The bright spot is that the cash and fixed income allocations have held up well with the bell-weather Barclays Aggregate Bond Index rising 8% during the quarter.
Very Swift and Very Large Government Actions
The size and timing of the federal government’s response to this health emergency is truly something to behold. Clearly, officials learned from the 2008 financial crises where monetary policy action was too slow, the size was too ineffectual and political wrangling caused delays in necessary programs like TARP (Troubled Asset Relief Program). In one week in March, both monetary and fiscal policies were created, debated, and enacted which we can credit with slowing the bleed in financial markets. The graph below is a great picture detailing the dollar-value and speed of this stimulus plan, versus our last crisis in 2008, courtesy of the Wall Street Journal.
Important Federal Reserve Monetary Programs:
- Cut Fed Funds rates 100 basis points to near zero
- Announced unlimited buying of government securities, MBS
- Created $300B credit back-stop for short-term commercial paper
- Insured the $4T money market industry from “breaking the buck”
- Enacted Main Street business lending program complementing efforts of SBA
CARES Act Signed into Law in Record Time:
- Raised and extended unemployment benefits to $600/week for up to four months
- Created loans for small businesses -forgiven if used for payroll
- Created relief for student loan debt, tax filing deadlines, state & local governments
- Bailout of strategically important industries (airlines)
When is the Bottom and What Does Recovery Look Like?
No one knows exactly when the bottom in equities will be. Until we have an idea of when the virus can be contained, we likely can’t move past this bottoming process that we think will continue through April, with even newer lows ahead. We often look to other times of drawdowns to determine where we are relative to past recessions. As shown in the chart below, we’re still writing the history of this 2020 decline, but the important point to note is the strong recovery period during 250 days after a recession ends.
A lot of debate has also focused on what the recovery will look like once we get through the COVID-19 pandemic. A “V” recovery brings economies and markets swiftly back (maybe not to prior peak) from declines and is usually a recovery that includes monetary and fiscal stimulus, pent-up consumer demand and businesses wanting to make up for lost production. One could say all those conditions are likely to exist this time around. There is also a “U” camp that believes the recovery will take much longer (2-3 years) because we cannot just restart a global economy that was deliberately halted. If we don’t find a cure or better preventative measures for COVID-19, there is also talk of a “W” recovery, which would include a lull in the summer and a resurfacing of the virus in the Fall. American’s compliance to social distancing, and our world healthcare experts preventative measures, are our two best weapons to defeat this virus and return back to a growing and prosperous economy. Time will tell.
What is Sandy Cove Doing?
First, we are staying healthy, social distancing and working for you from our homes or the office. Second, we have communicated timely information over the last month as events have unfolded at breakneck speed via our Flash Reports, blog posts, emails and phone calls and we hope you find them all helpful.
With regards to client portfolios, it’s worth mentioning a few moves we have made, are making or will make. In late 2019, we reduced our asset allocation to emerging markets and sold down those positions in client accounts. In February 2020, as virus fears hit our shores, we made sure to have 3-4 months’ worth of cash on hand for all clients receiving monthly distributions. Also, in February, we turned off the dividend reinvesting feature in client accounts to further preserve cash. We have started the processes of upgrading portfolios by selling passive benchmark ETFs in favor of actively managed funds where the investment professionals are picking through the value created this month and buying what they believe are the winners for the upturn and years beyond. We think active managers will have a leg-up on indexing and want to position our clients to better reap those gains.
Lastly, we have seen a 70% equity / 30% fixed income asset allocation portfolio come out of target range by about 5%, so the market has “de-risked” portfolios given the big declines in equities. We are set to rebalance portfolios when we believe there is ample visibility that we are at/near the bottom of this bear market. As I mentioned above, no one can time the markets and we are not professing to know when exactly the bottom will occur. We would rather be a little late and catch the rebound, then a little early and lock in losses.
This global health emergency is like no other we have faced in modern times, and has confounded economists on just how to model a shut-down of almost every sector of the world economy. In the U.S., expected second quarter GPD growth rates from major investment firms vary from Citigroup and UBS down 12%, to a very bearish Goldman Sachs down 24%. We are in the eye of the hurricane right now and economic data will continue to report unprecedented declines in employment (3.2 million unemployment claims last week and 6.6 million this week). Unemployment could, for the short-term, rise to 10-12%. Suffice to say, our path out of COVID-19 will likely create a recession which is defined as two sequential quarters of GPD declines.
We are not in the camp believing this is an economic depression, as the components simply aren’t there. Before COVID-19 hit our shores, we had a strong economy with most economic indicators still flashing positive. After COVID, we’ve had massive government aid and stimulus that is likely not over yet, and represents nearly 20% of GDP. Additionally, versus a depression, we know there is an end to this pandemic. Medical science will find a treatment, and eventually, we will all get back to regular business and regular living.
As always, your Sandy Cove team is available to answer any questions about the markets or your portfolio.