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April 2020 Investment Commentary
Thanks to an invisible, emergent threat, financial markets fell from a comfortable cruising altitude in breathtaking fashion, in a matter of weeks. COVID-19 was already well established, but smoldering, and appeared contained half a world away. The coronavirus’s lethality seemed to be well under the rates of earlier respiratory viruses, not far above flu levels. But with a seemingly quick trip to Europe, Iran, South Korea, and the U.S., or more accurately, a quick manifestation of new cases following an earlier, unseen spread, this virus had new life. And it posed an immediate and major threat, to everything.
|First Quarter||Last 12 Months||Five Years (ann.)|
|Developed International Stocks||-22.8||-14.4||-0.6|
Beginning in late February, market volatility spiked and losses cascaded, as a new, frightening economic picture took quick hold. COVID-19 brought the ultimate toxic mix: human tragedy on a potentially major scale, an exponentially spreading disease with no known cure and an agonizingly long vaccine timeline, with our best response a need to induce a deep economic coma of indeterminate length. Financial markets most abhor uncertainty, and it would be hard to draw up a scenario any darker and more uncertain than this one.
All asset classes reflected distress over the quarter’s final weeks. Stocks, having established all-time highs in mid-February in the U.S., saw drops in the mid 30%s, with most regions following suit (China, ironically, an exception, off far less). Losses were trimmed late in the quarter. Bonds held up well but still were volatile, swept up in panic selling and a liquidity squeeze as investors craved cash. This took down all maturities and quality levels in essentially all categories until tensions cooled amid widespread Federal Reserve support measures. Oil prices registered the most precipitous losses, falling 66.7%, the worst quarter on record. Saudi Arabia chose a bad time to pick a supply fight with Russia, neglecting to factor in the dire prospective state of global demand in a sharp recession.
As we’ve written previously, client portfolios have performed about as expected, with significant losses coming from the equity allocation, roughly aligned with benchmarks. Hedged assets posted losses, but less sharply than long-only stocks. Bond allocations, spanning a variety of strategies, appear about flat, also close to benchmarks, providing welcome defense. Direct commodity losses thankfully were avoided, as the last of this exposure was moved to bonds three months ago.
The depth and breadth of the upcoming recession is a guessing game, more than usual. No one knows how long the coronavirus will maintain its power and how long comprehensive social distancing measures will be needed. COVID-19 has transformed a healthy economy into a largely shut down economy with shocking speed. By itself, an immediate estimated 75% drop in travel and related hospitality activity is enough to push us into recession. Throw in depressed auto sales, big box retail, the energy economy and much of manufacturing, and we could see a concentrated hit on an unprecedented scale in the second quarter, easily exceeding the global financial crisis’ worst quarter, down 8.4% in the fourth quarter of 2008. Unemployment, just in February at an all-time low of 3.5%, also could breach the worst of the financial crisis – 10.0% in October 2009.
The federal response, informed by lessons from 2008 and 2009, has been quick and very, very big. The Fed’s Jay Powell effectively pledged unlimited support via emergency rate cuts back down effectively to zero, pan-category bond purchases and ubiquitous liquidity enhancement. This included unprecedented direct lending to corporations in need, backstopped by the U.S. Treasury, with aggregate lending power upwards of $4 trillion. This was later joined by a $2.3 trillion fiscal support package, the CARES Act, to help businesses and individuals survive the shutdown. Here also, the scale is massive: the $2.3 trillion figure more than triples the stimulus bill from early 2009; it is just above 10% of our total 2019 economic output of $21.4 trillion; and it is just under half the $4.8 trillion federal budget for fiscal 2020. The longer-term implications, notably national debt, have been set aside in the interest of short-term survival.
The key but indeterminate factor, length of shutdown, will hinge on factors all of us are focused on every day: efficacy of social distancing, benefits, better late than never, of more widespread testing and tracking, and changes in the rates of spread and mortality. Models abound: The Wall Street Journal on March 31st depicted the “Murray model”, produced by the University of Washington’s Institute for Health Metrics and Evaluation. The model scales for population and extrapolates fatalities from data timelines of earlier hot spots that instituted social distancing. In Wuhan, for example, daily deaths peaked 27 days after social distancing was implemented. We’re in week three in the early-acting U.S. states such as California and New York. Generally, while tweaked by region, the model suggests peaks occurring over the next several weeks, with an immediately subsequent easing of demand for health services, both equipment and people.
If confidence around peak timing advances, economic forecasting thus becomes sounder, and this would provide investors a better ability to discount the future and probability of recovery. Knowledge is power, and hard data, both good and bad (the last several weeks more a matter of bad and less bad), enables recalibration, and greater traction for investors. If, however, the COVID epidemic finds new ways to be elusive, mysterious, and threatening, traction will be much harder to reach, and volatility will remain elevated. On balance, we take solace from signs of progress such as the Abbott Labs five-minute COVID test, now in mass production near Portland, Maine, targeting distribution next week. This would provide critical help and improved tracking, which proved so beneficial in South Korea, among other countries.
With regard to portfolio positioning, here is what we are recommending:
- Rebalancing back toward existing tactical weights, which today includes moderately restoring equity exposure. As indicated in a prior email, portfolios were defensively positioned on January 1st and became more so with the equity drop in March. Not rebalancing would leave portfolios well on the defensive side of benchmarks. This creates a risk that portfolios would be hindered if markets were to recover.
- Upping exposure to active management, as we are now in an environment that is ever changing and one in which winners and losers will be more clearly distinguished. Specifically, we are introducing a new mid-cap fund, Eventide Gilead, with a biotech and health care bias as well as a social overlay.
- Trimming absolute return exposure in favor of added commitments to an existing global bond manager. This adds defense, and hedges against the equity restoration.
Importantly, existing managers already are well invested in areas that appear best positioned to weather this crisis, while also well placed for the post-pandemic world. Along with health care, including companies involved in COVID therapies, this includes technology firms, who provide services enabling remote access and on-line commerce.
We hope you are finding ways to get through this difficult time. COVID-19 began 12 time zones away. Now it is affecting all of us, directly and indirectly, this readership included. Our best thinking and our best feeling are called upon. We see humanity and, eventually, recovery.
We continue to operate remotely, but are readily available if we can help with your questions or concerns.
David S. Beckwith, CFA
Managing Director & Chief Investment Officer
This letter may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.