Q1 Market Review
This quarter saw the dawn of a new decade that will only be remembered for the human and economic carnage caused by the global pandemic of Covid-19. Our entire vocabulary has changed with phrases such as “flattening the curve” and “shelter in place”. As the globe responded to the pandemic, markets and economies were dramatically impacted. Volatility returned at levels unseen since the financial crisis of 2008. The indices routinely spiraled down 9% one day only to furiously rally up 10% the next. As the quarter came to an end, the impact of the pandemic had dramatically changed the way we live but financially, investors who had practiced a disciplined approach, weathered the storm and were appreciably less battered. Turning to the U.S. domestic markets, the S&P 500 index recorded one of its worst quarterly performances on record, down 19.6%. However, upon closer examination, there are key differences in the depth and breadth of the selling. The Energy sector was absolutely eviscerated by a dramatic drop in demand due to global shelter in place orders combined with a foolish price war between Saudi Arabia and Russia that pushed oil prices to levels not seen since the first Gulf War. However, sectors such as Technology, Health Care and Consumer Staples, performed relatively well (down 12% vs the S&P). The financial health of the individual companies made all the difference. Companies with strong balance sheets, low debt levels and an abundance of cash did well. Companies that were highly indebted did not. This builds on a theme we have been implementing for the past year that has tilted our equity portfolios towards quality.
The other segments of the US equity markets experienced even larger losses. The Russell Mid Cap index was down 27.07% and the Russell 2000 Small Cap index was down 30.61%. Consistent with the Large Cap theme, companies with weaker balance sheets were punished more than those with stronger financials. Compounding the volatility in this space was the fact that many companies of this size issue high yield (junk) debt. The uncertainty of these companies’ ability to service that debt led to extreme volatility in this segment of the market as owners of these securities sought to liquidate them to move to safer asset classes. Once again, we saw those companies with stronger financials outperform those with questionable balance sheets in the high yield space. International markets fared no better than their counterparts in the U.S. In the developed world, the MSCI-EAFA index was down 22.83%. In emerging markets, the MSCI-EAFA Emerging Markets index was down 23.60%. We saw a similar pattern in markets outside the US, where lower quality companies underperformed the broad market. We continue to underweight international markets as we are not as optimistic about their growth characteristics and believe their economies and markets will be slower to recover from the pandemic than the US markets.
If there was a bright spot to be found, it was the fixed income markets. The Barclays US Aggregate Bond Index was up 3.15% for the quarter. This was driven mainly by the move in interest rates and a flight to quality as investors sought safe havens for their money. The Federal Reserve lowered its benchmark Fed Funds rate in March to 0% and US Treasury securities dropped by 0.50% or more across all maturities. This decrease in yields drove prices higher, resulting in the positive return. Corporate bonds, especially those attached to companies with compromised balance sheets, did trade lower. These companies now face the additional danger of having their debt downgraded. We have been making changes in the past year to improve the overall credit quality of our portfolios for just this reason. One of the themes about which we consistently speak to clients is the importance of diversification within portfolios across all asset classes. That advice was paramount in the 1st quarter of 2020. While the S&P 500 was down nearly 20% and other equites were down even more, bonds were up 3%. The benchmark for our balanced portfolios (60% equities 40% bonds) was down 13.02%. The 40% allocation to bonds which returned a positive 3%, significantly mitigated capital impairment for clients. The key is to keep invested according to your personal risk profile. Looking ahead, we do believe there is a light at the end of the tunnel. While it is likely that we are currently in or will enter into a recession, we don’t believe it will be of significant duration. The wild card is how long the “Shelter in Place” orders remain and how quickly the economy gets back on track. Unlike the past 3 recessions, the economy did not enter into this downturn with an overvalued asset bubble like technology in 2000 and mortgages in 2008. This bear market is simply the result of a health pandemic. Therefore, when people return to their normal lives the demand for goods and services should follow. In fact, there may even be some pent-up demand for specific items. It is true that some businesses will be irreparably harmed. However, we believe that the void they leave in the economy will quickly be filled by other companies. Most likely, 2020 will be a tough year but we expect that by the 4th Quarter of 2020 or the 1st Quarter of 2021 we should be well on our way to recovery. As always, we are here to answer questions you have. We hope that you and your families are healthy and safe.
Marin Wealth Advisors