Is there anyone out there sad to say goodbye to the first quarter of 2020? There is so much we would prefer to forget about this year, yet we cannot because we are still in the throes of health and stock market uncertainty. It has not all been bad, though. Fond memories of extra family time, online game nights, and community bonding are forming and will not soon be forgotten. It is within this bittersweet backdrop that we take a step back and provide our synopsis of the first quarter of 2020 and provide the playbook going forward.
Dissecting Q1 2020
It was a challenging quarter for investors as equity markets fell globally. The combination of a pandemic, an oil price war, and a buoyant U.S. stock market that was pricing in high expectations proved a volatile concoction. The extent of the fall was not unusual for stocks in a bear market. What was surprising was the speed with which it happened. In just a little over a month, the S&P 500 fell 34%.
Instant Bear Market
Stocks went from gains to bear market almost overnight. In the span of a month (as shown below), stock valuations (as measured by the 12-month trailing PE ratio) went from full to cheap, before ending the quarter near average valuations.
Chart 1: A Difficult Start to the Year
The global spread of Covid-19 led to a sharp sell-off in equities. Fed action and fiscal stimulus helped to soften the blow, but not before valuations temporarily fell below average.
Historically five stock factors have been persistently rewarded: Good Value, High Quality, High Momentum, Small Size, and Minimum Volatility. As the market turned down, the hardest-hit factors were smaller stocks and value, though stocks with these characteristics were struggling even before the downturn. Historically, in market recoveries, Small Size and Value have been the best performers, so opportunities could be opening here.
Chart 2: Momentum and Min Vol the Relative Winners
In a difficult market, it was momentum and minimum volatility stocks that held up best, while smaller stocks and value continued to struggle.
Fixed Income allocations helped dampen the impact of falling equities, at least for those that avoided the allure of high yield bonds. It was not a stellar quarter for bonds, though, as corporates suffered liquidity fears in the wake of Covid-19 uncertainty. Fed intervention helped, and these protection assets proved useful levers for rebalancing as equities fell.
The Federal Reserve pulled out its complete set of tools and began work to stabilize markets. The Fed Funds rate was dropped to near zero, quantitative easing was restarted, and numerous programs were launched to ensure the smooth operation of the lending markets. The kitchen sink still appears to be in place, but when viewed in combination with the $2 Trillion Congressional stimulus plan, the Federal Government has dug deep into its bag of tools.
Chart 3: The Fed is Using its Toolkit
The Fed dropped rates, announced an unrestricted quantitative easing program, and launched multiple programs to ensure liquidity for borrowers during the crisis.
Gold and bonds were atop a fairly dismal Q1 leaderboard. U.S. Small-Cap stocks and Commodities (thanks to oil) brought up the rear. If nothing else, asset performance this quarter provides investors a reminder as to why a diversified portfolio can be so important.
Chart 4: A Fairly Dismal Q1 Leaderboard
Gold and bonds provided protection and a rebalancing lever for diversified portfolios. Commodities had a dismal quarter.
The Q2 2020 Playbook
In the wake of recent market declines and the uncertainty surrounding Covid-19, there are certain questions which we hear repeatedly:
- How low will the market go?
- When will the economy return to normal?
- How long will it take to recover recent losses?
Last week in Insights (Coronavirus & Stock Market: Your Questions, Answered), we wrestled with these questions. While we all would love clarity on all these points, there is an inherent flaw in their premise: they all require knowledge of the future, which is unknowable. Sure, we can follow the data and look to the past as a guide, but in the end, we just do not know.
Some may be disappointed to learn that their money-manger is not a soothsayer. It sure would make the job a lot easier. Personally, I would be terrified of any investment advisor that believes he can predict the future. Such notions of clairvoyance would undoubtedly lead to ill-informed market timing and be detrimental to long-term returns. At Strategic, we prefer data and facts to conjecture. Rather than try to predict the future, we prepare for it with a well-researched process founded on evidence and experience.
Our approach is no different in these difficult times as it is in a raging bull market.
- Start with a well-diversified portfolio with rewarded factors at the core,
- Rebalance regularly to systematically “buy low and sell high,
- Harvest tax losses to offset future gains where it makes sense, and
- Reallocate assets towards bargains as they emerge.
Thank you to our clients for entrusting us to help them navigate these difficult times. This too will pass, and when it does, we will all be stronger for it!
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets over $1.3 billion.Overview
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