The first quarter started out on a positive note, marked by strong earnings, economic data, and surging financial markets; however, the rest of the quarter was a different story after the S&P 500 peaked on February 19th. Concerns over Covid-19 (better known as the Coronavirus) plunged financial markets into their fastest bear market (a decline of at least -20%) in history. In addition, the volatility we saw in the equity and fixed income markets was truly historic. For example, the S&P 500 recorded its most volatile month in the history of the index in March with an average daily move of 4.8%. In addition, the Dow Jones Industrial Average (DJIA) posted its worst first quarter in history. The following Exchange Traded Fund (ETF) returns from Bespoke provide a thorough breakdown of how various indexes, sectors, and other asset classes performed during the first quarter.
In response, The Federal Reserve has acted swiftly by announcing two off-meeting rate cuts during the month of March (bringing the target Federal Funds rate near 0%) and relaunching its asset purchase program (more commonly known as Quantitative Easing). In addition, Congress passed, and the president signed into law, the CARES Act in late March which is a $2.2 Trillion spending bill to support individuals, corporations, small businesses, state and local Governments, and other entities. One relevant side note as it relates to retirement accounts is the suspension of Required Minimum Distributions (RMDs) for the year.
For context, consider the following comments, much of which is attributed to TS Lombard economist Steve Blitz and Barron’s writer Randall W. Forsyth; The CARES Act will boost the federal deficit to approximately 14% of GDP, which is staggeringly high, but less than the modern record of 27% hit in 1943 at the height of WWII. (March 30, 2020 edition of Barron’s Up and Down Wall Street column). This current deficit is different than the WWII deficit that was meant to produce materials which created jobs and income. Today’s deficit is meant to stave off personal and business bankruptcies caused by the government mandated shutdowns. There is no historical comparison for the magnitude of aggregate demand that is currently being destroyed, nor the magnitude of job losses in such a compressed timescale. Injecting trillions of Dollars into the economy may cover a short-term need, but the key question is what will be the longer-term effects once the pandemic recedes?
The bottom line may mean that we should brace for the potential of higher inflation. We are entering a period of monetarily financed fiscal policy just as the trend to de-globalization is accelerating due to the ongoing trade conflicts. The outcome of this could be very inflationary on a global scale.
As you watch the daily news cycle, the images can be daunting. You may be tempted to react and make changes in your portfolio based on the short-term news; however, market history rewards the long-term investor. The following chart from LPL Financial charts all market corrections (defined as at least a -10% decline) in the S&P 500 since 1980. While it is not yet known when the current decline will find a floor, history shows that markets have generally shown resilience following steep declines and have a consistent track record of moving higher from the lows. For example, the average correction in the S&P 500 since 1980 is -18.6%. A year later, the index was up an average of +23.2% and positive 90.3% of the time. Similarly, the index was up an average of +36.7% two years later and positive 86.7% of the time. While past performance is no guarantee of future results, the market has historically rewarded the patient investor for staying invested despite turbulent times like the ones we’re facing now.
Speaking more to prior health pandemics, we have a number of cases that provide a framework of how the market responded once the pandemic was over. While no prior cases caused as steep a decline as we’ve seen with Covid-19, markets have generally shown resilient responses as illustrated by the average 3 month (+3.08%) and 6 month (+8.5%) forward returns in the MSCI World Index. (Charles Schwab/Factset).
At this time, there is a great deal of uncertainty clouding the financial markets. Questions around earnings, economic data, and unemployment have rarely been more difficult to gauge. Until we can get some clarity on when the economy fully re-opens, a vaccine for Covid-19 (or at least a peak or decline in cases), and if monetary and fiscal stimulus begin to work, the answers will remain cloudy at best. With that said, we’re committed to a long-term approach and continue to both rebalance accounts (to take advantage of price dislocations that have occurred during the last few months) as well as reduce risk in portfolios. While we are not market timers, we can take measures to reduce risk which we feel is prudent in the current environment. We would also caution that recent volatility is not entirely attributable to the Coronavirus as prior to financial market declines in late February, valuation multiples were in lofty territory, corporate debt was at elevated levels, and the market was vulnerable to any kind of shock given that is was ‘priced for perfection.’ These issues and others will take time to resolve as the market reprices risk and imbalances need to be corrected. In our view, this will be a process that plays out over several months and quarters rather than a quick resolution.
In closing, the current news is a serious challenge to our country and the world and will leave lasting impressions that we admittedly can’t fully comprehend at the moment. With that in mind, we are here to guide you through these rough times in an effort to help you reach your long-term goals. We are currently working remotely and are available when you need us.
As always, feel free to reach out to us if you have any questions or concerns.
This commentary is provided for general informational purposes only and should not be construed as personalized financial or investment advice. Information has been obtained from sources deemed reliable but is not guaranteed. Securities and investing involve the risk of loss. No strategy can assure a gain or the avoidance of loss. Any comparative indices shown are unmanaged and are provided as an indication of the performance of a given segment of the capital markets. Indices cannot be invested in directly, and the returns shown do not reflect any fees, costs, or expenses. Past performance should not be relied upon as an indicator of future performance. Forward looking comments necessarily involve known and unknown risks and are subject to change. There can be no assurance that forward-looking statements will prove to be accurate, as future events could differ materially from those anticipated. We undertake no obligation to update forward-looking statements if circumstances or opinions should change.