Q1 2020 Market Results
The first quarter of 2020 was, without question, one for the history books. The world was introduced to coronavirus 2019, a.k.a. COVID-19, after its January outbreak in China. Although not overwhelmingly notable at first, the virus quickly spread in China, then to other countries and was officially labelled a pandemic on March 11. Investment markets were hit hard and fast. For the quarter, the U.S. S&P 500 index was down -19.60% with the current cycle low of -30.75% on March 23. The international market index was down -22.83% for the quarter and emerging markets were down -23.60% for the quarter. The U.S. aggregate bond index held up in the beginning, went down as the crisis evolved, then experienced a Federal Reserve (Fed) supported rally to end the quarter up at +3.15%. Short-term treasuries also played the role of safe haven with a quarter gain of +2.85%.
What we found amazing during this drawdown is how much this market has looked like what occurred during the 2008-2009 Global Financial Crisis (GFC). And the simple fact is that we did not expect such a strong reaction. The GFC was clearly a situation where the world was entering a recession, but the degree of financial imbalance was extraordinary and the entire global banking system was brought to its knees. Recall that Lehman Brothers, a financial household name that had been in business for 150 years, went bankrupt in September 2008. The COVID-19 crisis, on the other hand, seems far less structural to us, and much more event-driven, than the GFC. Though the short-term impact to gross domestic product (GDP) will be severe, we don’t think the depth of the market crash is sustainable in the long run. The U.S. economy was solid going into this and we believe it will be solid coming out. We are optimistic that the market over-reacted and level heads will prevail.
The first quarter was an absolute wash for most investors. Yes, bonds offered some buffering for lower risk portfolios, but the overall drawdown was so much that most any portfolio, regardless of holdings, finished the quarter down. These are the types of events that rattle investors and even get some to throw in the towel and shift to cash. History has shown this is not the best choice in most cases, and especially in one where we believe recovery is as simple as waiting out the virus duration. These are the times when investors have to hunker down, grit their teeth, and forge ahead. The losses in the first quarter resemble what happened in the fourth quarter of 2018, and at the time we recommended hanging on. We believed the market reaction was inconsistent with the economic fundamentals and felt recovery would occur within six months. The actual recovery took four months. In the case of COVID-19 the damage is deeper than in Q4-2018, but we still believe this market has over-reacted and a recovery is very possible in twelve months. Yes, we’ve extended our recovery expectations from our original three to six months, then six to nine months, to now nine to twelve months. As COVID-19 has evolved, the depth of the economic disruption has become clearer and we believe the depth of the crisis will require more time to heal. The March 19 unemployment report is a good example of the speed and depth of the crisis with 3.3 million new unemployment filings - nearly five times greater than the previous record set in 1982. And it will likely get worse before it gets better.
In terms of managing portfolios, we believe the coronavirus pandemic has created a buying opportunity in the markets. You don’t get to buy equities at a 20% or 25% discount very often. We have been using a disciplined approach with new clients or clients who have significant cash. For the remainder of clients we intend to make trades, but only when we feel we are near the bottom of the cycle. March 23 has been the cycle low so far, and a mild recovery has been seen since, but we believe there is room for the markets to move lower. That is based on our analysis of the GFC and using that experience as a guide. We expect we will be making these trades relatively soon.
One final thought: though we believe a nine to twelve-month recovery is likely, we don’t necessarily see that recovery bringing us all the way back to the previous all-time S&P 500 high of 3373 on February 19. As we suggested last quarter, we feel the markets were going a bit too far on the positive side, perhaps beyond reasonable valuation. Thus, we feel the recovery will bring us more into the 3100 to 3200 range on the S&P 500 – a 6%-7% downward adjustment from the peak.
Q1 2020 Notes
In response to the COVID-19 crisis the Fed quickly reduced interest rates to 0% and instituted programs to maintain liquidity and support the corporate bond market. That’s the bond support we mentioned earlier. The Fed essentially injected up to $4 trillion into the economy and banking system. Then our legislators passed a $2.2 trillion fiscal support bill, signed by the President, to provide rapid short-term relief to workers and businesses. Both the Fed and Congress reacted in ways very similar to what they did during the GFC, but much faster. The message is clear: go big and go fast. This is mostly because the federal and local quarantine efforts are essentially closing our economy. The speed of the contraction is unprecedented. Very little business gets transacted when everyone is sitting home. It has been quite staggering to watch unfold.
To close out this letter, I wanted to take a moment to look at some history. Personally, we’ve never seen anything quite like COVID-19 before, but that doesn’t mean it’s never happened. You can go all the way back to 1918 when the world was hit with the Spanish Flu pandemic that killed 675,000 in the U.S., our worst pandemic of the 20th century. But there are two other more recent examples, the first is the 1958 Asian Flu pandemic that killed about 100,000 in the U.S. and then the 1969 Hong Kong flu that also killed about 100,000 in the U.S. Infection and mortality rates differ between all of these examples, but the last two pandemics did exhibit a degree of government coordination and mitigation efforts, though nowhere near what we have today with COVID-19. Keep in mind that during that time we didn’t have a 24/7 news cycle, the Internet, or social media to help force the mitigation message. In all of those cases there were economic affects as behaviors changed, and all of them saw a return to normal as the virus spread slowed. We believe that will happen this time too. And we keep reminding ourselves as the story continues to worsen in the short-term.
As always, we will watch and research the global economy and make investment choices to the best of our ability for each and every client portfolio. If you have questions about your portfolio, our views expressed in this letter, or anything else financial, please do not hesitate to call.
Barron Financial Group, LLP is a fee-only Registered Investment Advisor regulated by the Connecticut Department of Banking.
This newsletter is for general information only and should not be considered investment advice. Investors should consult with a trained investment professional to discuss their particular situation.