First Quarter 2020 Market and Economic Review
The first quarter of 2020 was record-setting – in both directions. US equity markets moved to a record high in February. Unfortunately, they then set another record on the downside in March and for the quarter. The declines were caused by an oil production war between Russia and Saudi Arabia, a decrease in demand, and the worldwide spread of the COVID-19. This resulted in the quickest move from market highs to a bear market that has ever occurred. The Dow and S&P 500 both recorded their worst first quarters ever.
The S&P 500 index, which tracks large U.S. companies, fell 20.0% for the quarter. The Dow Jones Industrial Average fell 23.2%. Note that both indices fell more than 30% from their peaks, but these quarterly results are affected by gains at the beginning and end of the quarter.
Small US companies have been some of the hardest hit by this crisis. Many are involved in energy as well as leisure like hotels and restaurants. They often do not have the cash reserves that larger firms possess. The Russell 2000 index, which tracks small U.S. companies, ended the quarter down 30.58% and was down over 42% peak to trough.
Countries overseas are struggling with the same issues. It may surprise many that the China Shanghai Index is the only major index in the world that is not in a bear market which is defined as a 20% drop from a high. It finished the quarter at -10%. This is because while they were first to endure the virus, they were also the first to return to work.
Europe was hard hit with Italy being an early epicenter of the virus. The Euro Stoxx 50 dropped 26.94% for the quarter. The broader MSCI EAFE which follows Europe, Asia, and the Far East was down 22.83% for the year.
Bonds are normally an insurance policy for times of market turmoil, but prices there fell as well. Banks and investors sold all kinds of fixed income to raise needed cash. The Bloomberg Barclays Aggregate did manage a gain of 3.15% because of large amounts of Treasuries. However, US Investment Grade Corporates dropped 3.63%. US High Yield was down 12.69%. The broad Bloomberg Barclays Global Credit Index was down 6.23%.
For a diversified portfolio, here is an update of benchmark returns.
* Each benchmark is allocated based on assumed Risk Profile of underlying indexes.
**Benchmarks include a mixture of ICE BofAML US 3-month Treasury Bill Index, Barclays Global Aggregate Bond Index, Barclays US Aggregate Bond Index, Bloomberg Barclays Multiverse, Bloomberg Barclays Global High Yield, Bloomberg Barclays US Credit, MSCI EAFE Index, and the Value Line Composite Index (Geometric). These benchmarks are the same as those in the Risk/Return and Account Analytics sections of client quarterly performance reports. By comparing your portfolio’s return to the benchmark with the closest risk/return characteristics, you get a more accurate reading of portfolio performance than using a less diversified benchmark, such as the S&P 500 index.
Worries of a US/China Trade War and Hong Kong unrest last quarter have been replaced with more pressing issues. The COVID-19 pandemic has forced countries to respond with social distancing and the voluntary shutdown of their economies to avoid overwhelming healthcare systems. This put the United States into an immediate recession.
The U.S. GDP, which was running at a 2%+ annualized rate, will plummet for the upcoming quarter in a historic drop and will likely stay negative into Q3. Actual numbers are almost impossible to estimate because it depends on the trajectory of infections across the United States. In the first two weeks of the acceleration in the United States, unemployment claims have been filed by an unprecedented ten million workers. For a typical two-week period, unemployment claims would normally register around 500,000; so, numbers this much higher effectively confirm a recession. We expect the unemployment rate to continue to rise into the double-digit range by the end of April or early May.
Oil and energy added to the dire economic environment. The energy industry was the worst-performing sector, down 51.06% for the quarter. The price of oil dropped 66.46%. This was partly caused by a lack of demand as fewer cars, planes, and ships were using oil due to the virus. On top of that, Saudi Arabia and Russia began a dispute and increased supplies to take market share from each other. This would have been very beneficial to the US years ago, but now we are one of the leading oil producers and it will bankrupt small companies and put stress on lenders to those industries.
The energy companies, airlines, hotels, and many others at the center of shutdowns have been drawing heavily on their credit lines from banks. The US banks are in excellent shape (unlike 2008), but the huge cash draws are causing them to sell large amounts of their bonds and are stressing financial markets with the volumes. Regulations and ratios on bank holdings are also causing problems and will likely be revised by the Fed.
In our view, three things must happen to end this downturn. First, the Federal Reserve needs to ensure that the credit markets function properly. Second, the federal government needs to respond with enough fiscal stimulus to help employees and businesses weather the storm. Third, the rate of infections in the US needs to peak and there needs to be hope for treatments and a vaccine for the second peak of infections expected next winter.
The Federal Reserve has responded to the stress in the bond markets by cutting interest rates to 0% to 0.25%. They have also provided over $2 trillion of liquidity to buy Treasury bonds, mortgage bonds, corporate bonds, and other assets. Unlike past programs where they announced a maximum dollar amount, this time they said it will not be limited. All these programs are stabilizing the bond markets, but some programs will take a couple of weeks to ramp up. We feel good about step one.
Congress did pass several phases of fiscal stimulus, including an $8.3 billion program aimed specifically to fight the virus; $100 billion in paid sick leave, unemployment, and food assistance; and $2 trillion in direct payments to taxpayers, small business loans that can be forgiven if workers are retained, larger business loans and grants, expansion of unemployment and many other provisions. By our calculations, these programs would be sufficient for about a two-month shutdown of consumer spending. If things go longer than this, there will be a need for additional legislation. We’ll call step two a good start, but the final outcome is TBD.
Last is the flattening of the infection curve nationally. Mathematical models are giving very different predictions due to unknows in the virus itself, the effectiveness of treatments, and the rate of compliance with social distancing. We do think we will see the peak in the US during April, but the downward slope will be slower than the upward slope. We do know the curve will flatten and descend, but timing is key and still unknown.
These are trying times in the economy and that has obviously translated into all investments. It tests our emotions and commitment to long-term plans. In the short-term, fear and greed will cause wild fluctuations which no one can predict. In the long-term, it is about the companies that will provide needed services and earnings. Though the markets focus a lot on quarter-by-quarter earnings, a very large percentage of a company’s value is on next year’s earnings and earnings thereafter. We are focusing on companies that will be around to have those earnings next year and have balance sheets and business plans to capitalize on this environment.
We will continue to monitor portfolios and make changes as appropriate. We wish and hope that all stay healthy and safe.