Q1 2020 Market Commentary + Outlook

The world over is grappling with the life-changing impacts of the coronavirus pandemic. The introduction of the novel coronavirus spelled an end to the longest-running bull market in United States history and has caused significant short-term economic damage at home and abroad. In the face of so much uncertainty, we encourage individuals to be safe, maintain a long-term investment view, and remain patient during the upcoming periods of heightened volatility.

After opening the year notching all-time highs, the S&P 500 index swiftly reversed course. In mid-March, the large-cap index declined more than 20% from a record close reached less than a month prior. The drop officially brought an 11-year bull market to an end, the longest-running bull market in United States history. Through the first quarter of 2020, the S&P 500 dropped 19.6% as fear and uncertainty surrounding the global fallout of a pandemic seized markets.

The sell-off in equities has been sudden and marked by extreme volatility. Sharp daily declines in the S&P 500 index triggered circuit breakers that temporarily halted trading multiple times in March. The CBOE Volatility index, also known as the VIX, reached a record high in the month, surpassing a previous high set in November 2008.

All 11 underlying sectors of the S&P 500 index declined over the quarter, with Financials and Energy being the hardest-hit. Collapsing oil prices resulting from the production war waged by Saudi Arabia and Russia only added to fear and contributed to poor performance among energy companies and their lenders. Though still down double digits, Technology, Healthcare, and Consumer Staples sectors held up relatively well.

Growth stocks performed better than value stocks and small-cap stocks underperformed large-cap stocks. The Russell 2000 index of small-cap stocks declined 30.6% over the quarter. Despite a mostly indiscriminate decline in stocks, investors showed a clear preference for companies with strong balance sheets and those that are less impacted by social distancing. Retail, travel and leisure stocks were among the hardest hit.

International stocks couldn’t avoid the same fate as their domestic counterparts. The MSCI EAFE index, measuring the performance of developed country non-U.S. stocks, fell 22.8% over the quarter. Meanwhile, the MSCI Emerging Market index fell, 23.6%, with oil-producing countries declining the most. Interestingly, stocks in China were among the best performers, dropping just 10.2% over the quarter. Lockdowns in Wuhan, the original epicenter of the virus, are being lifted in April, and data suggests new cases of COVID-19 have trailed off considerably since the outbreak began in the country in December 2019.

The first quarter of the year has been equally eventful for bonds. In light of the global sell-off of equities, it is tempting to overlook some relatively bright spots in the fixed-income market. The Bloomberg Barclays U.S. Aggregate Bond index returned 3.1% during the quarter, while the broader Bloomberg Barclays U.S. Universal Bond index returned 1.3%.

The risk-off environment that arose in March saw investors seek safety in U.S. Treasury bonds, driving the yield on the 10-year bond down 122 bps, from 1.92% to 0.70%. The Bloomberg Barclays U.S. Treasury index returned 8.1% over the first three months of the year. The flight to safety in fixed-income markets also resulted in a 13.1% decline in high yield bonds, with investors growing concerned about the ability of some issuers to survive the ongoing shutdown of economic activity brought on by social distancing.

Bond trading experienced significant liquidity constraints and pricing dislocations during March as many trading desks virtually shut down, and traders were not prepared to work remotely. As a result, exchange-traded funds (ETFs) across multiple fixed-income asset classes traded at significant discounts to their net asset values, a rare phenomenon.

Partially in response to the liquidity constraints that have beleaguered fixed income markets, the Federal Reserve initiated a new round of quantitative easing and a host of other programs to increase liquidity and stabilize pricing. The list of assets the Fed has pledged to support includes Treasury bonds, mortgage-backed securities, investment-grade corporate debt, and commercial paper. The new round of quantitative easing kicked off after the Fed cut the federal funds rate to an all-time low of 0 and 25 bps.

The U.S. economy came into the year on decidedly firm footing. The economy grew at a 2.1% annualized rate in the fourth quarter of 2019, as measured by gross domestic product. As recently as February, the official unemployment rate was just 3.5%, a 50-year low. That said, as new data trickles in, it appears the economic impact of the coronavirus will be historic. Weekly jobless claims filed at the close of March totaled 3.28 million, an all-time high. For comparison, the previous high of weekly jobless claims was 700,000, set in 1982.

Predictions concerning the severity of the economic impact of the coronavirus have been wide-ranging. Economists believe that the economy has fallen into a recession, with the only questions being how deep the downturn will be and whether it will be reflected in the first quarter or second quarter results. Still, economic forecasts are notoriously difficult to make, involving several interconnected variables. The number of unknowns involved at this moment makes economic forecasting even more challenging. Arguably more important than economic data are the data surrounding the pandemic. In general, investors are anticipating very dire economic data given the virtual shutdown of economies around the globe. However, they are paying close attention to the medical statistics and are looking for signals that the COVID-19 outbreak is stabilizing and that the end of social distancing is approaching.

Still, there are reasons to remain optimistic about the longer-term health of the U.S. economy. The Federal Government has taken swift, proactive measures to lessen the blow of the inevitable negative impacts of the coronavirus. Just one day after the record-setting 3.28 million jobless claims were filed, a $2.1 trillion stimulus and bailout relief package, known as the CARES (Coronavirus Aid, Relief, and Economic Security) Act, was signed into law. Highlights of the CARES Act include $349 billion in forgivable loans to small businesses, $301 billion in direct payments to consumers, and $250 billion in expanded unemployment insurance.

Additionally, the Act provides $150 billion in aid to states and $471 billion in loans to businesses, states, and municipalities. The Act also provides $61 billion in relief to hard-hit airlines. Congress has already begun discussing additional financial support that may be needed to support the economy.

As noted above, the Federal Reserve also stands at the ready to provide stability to the financial markets. It has enacted expansionary monetary policy through its slashing of the federal funds rate. Although additional rate cuts may not be an option, the Fed has shown a willingness to expand its balance sheet and purchase securities to provide liquidity if needed.

In recognition of the difficult times that lie ahead, governments around the world have enacted similar fiscal and monetary policies to limit the economic impact of the coronavirus.

The opening months of 2020 have been truly historic. News regarding the novel coronavirus is breaking at a dizzying pace. Times are marked by extreme fluidity and uncertainty. Just one month ago, the U.S. economy was growing steadily, and unemployment was at levels not seen in half a century. The S&P 500 index was in the midst of the longest-running bull market in history. Clearly, these trends have reversed quickly. In the coming months, the unemployment rate will increase, and the stock market will witness more volatility. Though the present situation might seem interminable, it is crucial to remain calm and maintain a long-term perspective. During past recessions, governments tended to intervene slowly, and the fiscal and monetary stimulus efforts were reactionary. In this case, we are witnessing record amounts of stimulus in anticipation of a slowdown. The pandemic will undoubtedly damage the economy severely in the first half of the year. Before the virus, there weren’t any structural issues that typically cause a recession, such as excessive borrowing or restrictive interest rates. Therefore, it is reasonable to expect a relatively rapid recovery in the economy after the virus has been contained. Financial markets tend to lead the economy, so we expect stocks to begin recovering before the economic data have notably improved. However, we believe volatility will remain high until the COVID-19 statistics start to improve.