We began the year on the heels of the longest economic expansion on record. Much of the market tail risks had dissipated by late 2019, and we were lauding the Federal Reserve for its shift to a more relaxed monetary policy. The market and economy seemed well-positioned for continued late-cycle growth. Our main concerns centered around trade-related geopolitical flare-ups and the upcoming election.
Few anticipated a viral pandemic, and fewer still could have predicted the unprecedented shuttering of the global economy. No one expected such market turmoil, nor the premium placed on liquidity, and no one could fathom the extraordinary action from global central banks and governments. In short, this cycle has been cut short by a black swan event.
January and most of February saw the market continue to set new highs despite increasing concerns surrounding the potential for a global spread of the virus. Markets started declining on February 19th after Italy and Iran both announced outbreaks (the first outside of southeast Asia).
Over the next 16 trading days, U.S. markets descended into a bear market at the fastest pace ever as the virus quickly spread globally. This swift change in sentiment led to the largest quarterly drop in the Dow since 1987 (-23%) and the largest S&P 500 decline since 2008 (-20%). Market volatility was also unprecedented as the VIX (a measure of the stock market’s expectation of volatility) hit all-time highs while the average daily change in the S&P 500 was 5% in March. Safe havens were rewarded as the 10-year U.S. Treasury gained 12.1% and gold was up 4.5%. Given all of the above, it is important to note that longer-term performance is, rather remarkably, in line with historical averages — the S&P is up an annualized 7.7% over the past five years.
At this point in the crisis, it is imprudent to predict the economic ramifications of the global shutdown. Virtually every macroeconomic data point is directly or indirectly derived from revenues. When gross receipts cease, payrolls shrink, wages are cut, capex plans are abandoned, and loan and lease delinquencies rise — all lead to contagion across sectors and asset classes. We are only at the start of this cumulative process as the ultimate cost will depend on the duration of the shutdown and the success of government policies to backstop employers and households through things like direct payments, loans, and enhanced unemployment benefits.
Historically, economic cycles tend to be marked by long expansion periods and short contraction periods. Hence, perspective is essential. Given the obscure nature of this crisis and the subsequent speed of the economic and policy reaction, it is conceivable that this contraction — while likely severe — could be short-lived. This phenomenon is typically pronounced in equity markets as they typically bottom before the economy because, at some point, the market has already priced in the bad news, and investors start to anticipate a recovery.
A New Framework
Last month, we introduced the three phases we believe the markets will follow throughout the crisis. The first phase, dominated by elevated uncertainty and anxiety, has been characterized by high volatility and unusual correlations (indiscriminate selling). We now feel that we are nearing the end of this phase and will look to episodic leveling and the effectiveness of the monetary and fiscal responses to provide cues. Going forward, investors need to remain nimble while actively seeking opportunities and remaining largely defensive in this low return, high-risk world.
As wealth advisors, it is our responsibility to help our clients navigate market conditions, adjusting portfolios based on risk parameters to meet financial goals. Given this framework, we continue to approach equities with patience while looking for prospects to upgrade individual holdings. At the same time, risk management techniques — such as asset class diversification, rebalancing, and being mindful of sector exposures and concentrations — remain critical as we navigate the current market landscape. We recognize that each client’s goals and objectives are unique. Ultimately, the manner in which COVID-19 will affect us, mentally, physically, and emotionally, will vary based upon our individual circumstances and perspectives.
In this especially challenging time, we thank you for your confidence and trust in us. We encourage you to contact your portfolio manager with any investment questions, concerns, or perspectives as 2020 continues to unfold.
Mr. Heckscher is Senior Vice President, Director of Fixed Income, and Chief Investment Officer of Pennsylvania Trust.
Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome — including performance — is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.