If you'd like to skip the commentary and just review the quarterly market performance in charts, click here. Link will open as a PDF in a separate window.
As I wrote last quarter, the decade of the 2010s was the first one since 1850 during which the U.S. didn’t experience a single recession. Market returns for all years, other than 2018, were positive, and it was the market’s least volatile decade since the 1960s. However, there is an old Wall Street adage that markets take the escalator up and the elevator down, which is what we have just witnessed. For the entirety of the 2010s, markets took the escalator up, and then didn’t bother waiting for the elevator to arrive in Q1. Instead, they jumped into an open elevator shaft, propelled by fears of the coronavirus fallout and its likely economic impact. This made for an investor experience unlike anything we have seen since at least the fall of 2008.
The MSCI All Country World Index, mostly comprised of larger companies around the globe, fell almost 23% during the quarter—more if measured from its early February high, with an intra-quarter peak-to-trough drop of 35% at the worst of it. However, other important portfolio components were hit even harder. Small companies in the U.S. and elsewhere fell between 27% and 36%; value holdings around the globe were down as much as 29%; and U.S. real estate fell 33%.
Adding salt to the market’s already-painful wounds, oil plunged 66% on a race-to-the-bottom price war between Saudi Arabia and Russia. And, China, of all places, put in the second-best market performance of any country, down "only" 10%. Short-to-intermediate term investment grade corporate and government bonds were up between 1% and 3%, even though high-quality municipals dipped slightly, off about 0.6% on liquidity concerns in the muni market, especially in the lower quality tiers. The Bloomberg US Aggregate Bond Index fell even further, down about 3% for the quarter. In short, it was an ugly quarter almost everywhere.
These numbers, while painful to read, fail to convey just how scary the quarter was for investors, with volatility surging towards levels only seen during the 2008-9 financial crisis and the early 1930s. Most of this fallout was not driven by fear of the coronavirus itself, but instead by a high degree of uncertainty and by concern around the economic costs related to the global efforts to mitigate its spread. But, despite the gut-wrenching volatility, we made it through an exceedingly difficult month, and volatility has dropped considerably in this first week of Q2. As I write this, nine days into the second quarter, global markets are still down, but encouragingly are more than 20% off their late March lows.
While the volatility has subsided, this does not mean the storm has passed. It is unclear how effective our mitigation strategies will be, what the exit plan will eventually look like, and what the ultimate cost will be to businesses and consumers when the worst of this is behind us. We do know the costs will be high and the economic damage significant, but many of those expectations are already factored into current stock prices. And, as they always do, markets will continue to adjust as new information—both good and bad—becomes available.
Reasons for Optimism
There are many things we now know about the virus and a long list of other imponderables we don’t know. This list includes how long this will all last and the course we will take as we navigate through the pandemic, while balancing public health needs against the economic costs. But, we do know we will make it through this crisis, just as we have made it through other seemingly existential challenges, from world wars to the Global Financial Crisis. Yes, risks abound but governments, markets, and companies can and will adapt just as they always have. And, we are witnessing that adaptation in real time.
The U.S. government has made it clear they are willing to go all-in on providing financial support to the hardest hit businesses, industries, and unemployed workers. Despite political rancor and partisanship in the U.S. being at or near all-time highs, a very divided Congress and administration have acted quickly, with indications that more help is on the way. Around the world, a global-scale Manhattan Project, if only loosely coordinated, is underway, with companies and research institutions everywhere working on key COVID-19 challenges: vaccine development, testing of novel therapeutics, and the rapid development and manufacture of testing supplies. The results can’t come fast enough. One example of the extraordinary ongoing effort is The Bill and Melinda Gates Foundation, which is funding research on seven vaccine protocols, two of which have already entered human trials. While development and testing of candidate vaccines is ongoing, the foundation is concurrently paying to build manufacturing capacity for all seven protocols, knowing that five of the seven facilities will likely have been wasted cost and effort. Despite what has been a late start in many corridors of power around the developed world, there has probably never been a greater global focus on a single issue than there has been on COVID-19, and that should offer us all encouragement.
In other positive developments, we see the lockdowns in Europe, while not over yet, are beginning to bear fruit, bending the epidemiological curve downwards in Spain, Italy, and several other countries. This is a critical first step in what will be a slow journey towards normalcy. Here in the U.S., it looks as if our own shutdown is also making a difference: the University of Washington IHME model estimates for COVID-19 fatalities between now and August have dropped from 100,000 to 82,000 and then to 60,000 over the last week, largely based on better-than-expected data from around the country, due at least in part to the ongoing shutdown.
In Wuhan, the original epicenter of the pandemic, things began their return to normalcy this week with the end of that province’s 76-day lockdown. Apple has reopened all 42 of its stores in China, while Starbucks has also reopened most of their locations across the country. Despite concerns about the veracity of some of the Chinese data (especially the total number of fatalities in Wuhan), there is little doubt that they have done a remarkable job of getting the pandemic under control. Those positive results have been reflected in the Shanghai Composite stock market index, which, as previously noted, has been the second-best market on the planet this year, down only 10%.
It’s also worth remembering that although the shutdowns are apparently effective and likely necessary in many countries—including ours, given the wide spread the virus has achieved—the shutdowns can’t and won’t go on forever. The cost of indefinite shutdown is certainly too high and undoubtedly a political non-starter. With some luck and the ability of businesses and governments to intelligently adapt with adequate testing and appropriate return-to-work protocols, we can at least hope for a return to some sense of normalcy well before widespread availability of a coronavirus vaccine. That said, it will take some time after widespread vaccination before we are able to return to anything resembling business as usual.
Remember: Don’t Skate to Where the Puck Is; Skate to Where It’s Going.
Two weeks ago, on March 26th, we saw what until then was the worst weekly job report on record. More than 3 million Americans filed a new claim for unemployment benefits. What did the market do that day? It finished up, closing the day more than 6% higher than it opened! How could this possibly be? The answer, of course, is that the market had already anticipated this dreadful number, and, in fact, the claims were a bit lower than the market had expected. This is how markets function: they take all available information and make forward-looking estimates, with security prices adjusting almost immediately to these estimates—often well before such evidence is officially of-record. This doesn’t mean markets are always right; but it does mean that markets are almost always forward-looking.
Another good example of this came during the 2008-9 financial crisis. Markets slid gradually through the first eight months of 2008 before falling off a cliff from September through early December. After landing painfully at the bottom of the cliff, they then continued a gradual slide from mid-December into early March. The U.S. market returns for those two years, 2008 and 2009, were -37% and +27%, respectively. The market fell in 2008 and ultimately rose in 2009, even though 2009’s actual economic data was much worse than 2008’s. Again, how could this be? The answer, of course: anticipation. In 2008, markets were anticipating 2009’s very bleak economy, and security prices adjusted accordingly; and, in 2009, even while the economic data was terribly depressing, markets were already looking ahead to improving expectations for 2010 and beyond. 2009’s +26% stock market bounce reflected that optimism.
With respect to the coronavirus situation and its impact on the current economy and the market, think of the situation as having three components: the public health situation (testing, infection rate, vaccine progress, etc.), the economy (employment, manufacturing activity, and the like), and, finally, the market’s reaction. While it would be easy to assume that the economy must improve measurably before security prices rise, in reality, the market just needs to have a reasonable basis to believe the economy will improve, not necessarily see that it has improved. And, any progress on one several fronts—testing, vaccinations, or return-to-work protocols—may be enough to bolster the markets substantially.
Finally, I will leave you with the chart below, which looks at China’s Purchasing Manufacture Index (PMI) data over the last year. The PMI is a commonly used measure of manufacturing activity and considered a leading economic indicator. We are not China, but they are two months further along the path than we are with respect to their shutdown and resumption of activity, so a look at this piece of leading economic data may be helpful.
As you can see, economic activity in China (the blue line) plummeted as the country went under lockdown and quarantine, just as much of the rest of the world is doing right now. In February, their PMI hit an all-time low of 35.7, which was even lower than during the 2008-9 financial crisis. While analysts had expected some improvement for March, the 52 number was a positive surprise and indicated an expansion in large enterprise manufacturing. This doesn’t mean economic activity in China has returned to normal levels yet. It hasn’t—and won’t for a while. Although we are just starting to see the impact of the shutdown here in the U.S., the China data offers hope that there is light at the end of what looks like a dark tunnel.
On that note, I wish you and yours well during what I know has been a difficult time. Have a happy Passover and Easter, and please let us know if there is anything we can do for you.
1. As I write this, news has broken that Suifenhe, a city along China’s northern border with Russia, is now under lockdown after 25 new cases of COVID-19 were identified.
2. That report would be eclipsed just a week later by the jaw-dropping initial unemployment report of another 6.6million.