Investors Endure Historic Volatility in the First Quarter
April 6, 2020
First and foremost, we hope this letter finds you, your family and loved ones healthy and safe. In keeping with our quarterly tradition, below is our review of the first quarter of 2020 as well as our thoughts as we enter the 2nd quarter. We will be posting another article soon with more details on what we expect going forward and what investors need to consider as they navigate this volatile environment.
Market volatility surged in the first quarter to levels last seen more than a decade ago during the financial crisis, as the COVID-19 pandemic swept the globe and prompted the partial shutdown of most major global economies, including the U.S., EU and most of Asia. But while the pandemic was the main cause of the historic volatility we’ve witnessed over the past several weeks, geopolitics and domestic political developments also impacted markets over the past three months.
To recap some of the main events of the 1st quarter of 2020, we started off with a geopolitical shock when the United States executed a tactical strike that resulted in the death of Iranian General Qasem Soleimani, followed by the Iranian response of a small rocket attack on a U.S. base in Iraq. Additionally, Iran mistakenly shot down a Ukrainian commercial airliner during the rocket attack, tragically killing all 176 people on board, and the global fallout from that all but ended the conflict.
As the geopolitical scare faded, investors’ focus turned back to the U.S.-China trade war, as both China and the U.S. signed the “Phase One” trade deal in mid-January. The agreement did not provide material tariff relief, however it did importantly signal no further tariff increases. As such, it provided needed clarity to global industrial companies and the markets. In response, stocks moved steadily higher, powered by the favorable combination of the U.S.-China trade “truce,” low interest rates following the rate cuts of 2019, historically low unemployment and steadily rising corporate earnings. Fundamentals for the economy and the stock market were very strong, and the S&P 500 hit several new, all-time highs between mid-January and mid-February.
But, starting February 20th, market volatility rose sharply as the number of active coronavirus cases began to dramatically accelerate in South Korea, Iran and Italy. The swift spike in new coronavirus cases outside of China resulted in a sharp drop in stocks in late February. Those declines were then compounded throughout March as the number of active coronavirus cases in the U.S. began to increase rapidly. The S&P 500 tumbled more than 25% from the mid-February highs to the late-March lows, amid rising fears that “social distancing” measures being implemented globally to stop the spread of the disease, would have a broad and substantially negative economic impact.
Positively, the U.S. government has acted to support the economy as the Federal Reserve cut interest rates to zero percent and implemented several important measures to provide short-term cash for corporations and ensure there’s plenty of capital for the broader banking system. Congress also passed multiple economic relief bills, the largest of which was a $2.2 trillion stimulus package aimed at providing support for businesses and displaced workers. The main intent of those actions are to help keep the banking and financial systems functioning in an orderly manner as well as supporting the economy through this unprecedented shutdown. Stocks reacted to these positive events by rallying sharply during the last week of March, although the major averages still finished the first quarter with large declines.
It’s fair to say investors and markets are facing a level of uncertainty that we have not seen in over a decade. The toll of the pandemic on human life and activity is something we have never seen before in modern times. And the magnitude of the economic impact it leaves in its wake is still uncertain.
But it is also true that the government has acted in a historically forceful way to support the economy and foster growth once the coronavirus pandemic has passed, and despite a volatile quarter, that is a comfort as we move forward.
1st Quarter Market Performance Review
The major U.S. stock indices all dropped sharply in the first quarter on concerns about the economic fallout from the coronavirus pandemic. But, the tech-heavy Nasdaq relatively outperformed the other three major indices, thanks to large-cap tech companies being viewed as somewhat insulated from the economic fallout compared to many other industries. The S&P 500, Dow Jones Industrial Average and Russell 2000 (the small-cap index) all saw larger declines in the first quarter.
By market capitalization, large caps outperformed small caps in the first quarter, and that is what we’d expect when market declines are being driven by concerns about future economic growth, because large caps are historically less sensitive to slowing growth than small cap stocks. From an investment style standpoint, growth relatively outperformed value, yet again, due to strength in large-cap tech.
On a sector level, all 11 S&P 500 sectors finished the first quarter with negative returns. Traditionally defensive sectors, those that are less sensitive to changes in economic activity like utilities, consumer staples, and healthcare, relatively outperformed, which is historically typical in a down market. Technology shares also outperformed the S&P 500, again due to relative strength in large-cap tech companies as their businesses are thought to be more resilient than other parts of the market.
Conversely, cyclical sectors, those that are more sensitive to changes in economic activity, badly lagged the S&P 500 in the first quarter. Energy was, by far, the worst performing sector in the S&P 500, as it declined sharply due to plunging oil prices. Material and industrial stocks also underperformed on fears of reduced future earnings if there is a prolonged global economic slowdown.
|US Equity Indexes||Q1 Return||YTD|
|DJ Industrial Average||-22.73%||-22.73%|
|S&P MidCap 400||-29.80%||-29.80%|
Looking internationally, foreign markets also declined in the first quarter, and again underperformed the S&P 500. Foreign developed markets slightly outperformed emerging markets, although barely so, as the economic fallout from the coronavirus is thought to be widespread globally. Meanwhile, emerging markets lagged both foreign developed markets and the S&P 500, although emerging markets did benefit from a rebound in Chinese markets in March, as China was successful in containing the coronavirus and their economy began to re-start late in the first quarter.
|International Equity Indexes||Q1 Return||YTD|
|MSCI EAFE TR USD (Foreign Developed)||-22.72%||-22.72%|
|MSCI EM TR USD (Emerging Markets)||-23.57%||-23.57%|
|MSCI ACWI Ex USA TR USD (Foreign Dev & EM)||-23.26%||-23.26%|
Commodities endured a historic collapse in the first quarter driven by steep declines in industrial commodities such as oil and copper. Oil plunged to multi-decade lows over the past three months on a combination of potentially reduced demand stemming from the global economic shutdown paired with surging supply due to the global price war that broke out following the failed “OPEC+” meeting in early March. Ultimately, prices declined to levels not seen since the early 2000s in the final days of the quarter. Gold, meanwhile, rose slightly in the first quarter as investors sought protection from uncertainty, although gold was very volatile in the month of March.
|Commodity Indexes||Q1 Return||YTD|
|S&P GSCI (Broad-Based Commodities)||-42.34%||-42.34%|
|S&P GSCI Crude Oil||-66.84%||-66.84%|
|GLD Gold Price||7.01%||7.01%|
Switching to fixed income markets, the total return for most bond classes was positive in the first quarter, although corporate bonds saw steep declines over the past three months, which is not surprising given the potential economic fallout from the coronavirus pandemic. The leading benchmark for bonds, the Bloomberg Barclays US Aggregate Bond Index, experienced positive returns for the sixth straight quarter.
Looking deeper into the fixed income markets, longer-duration bonds outperformed those with shorter durations in the first quarter and that’s what we would expect to see when expectations for future economic growth are falling sharply.
Corporate bonds saw substantially negative returns in the first quarter as high-yield debt badly lagged investment-grade debt. The underperformance of lower-quality corporate bonds also underscored rising concerns about future economic growth, and more specifically, the health of many global corporations.
|US Bond Indexes||Q1 Return||YTD|
|BBgBarc US Agg Bond||3.15%||3.15%|
|BBgBarc US T-Bill 1-3 Mon||0.47%||0.47%|
|ICE US T-Bond 7-10 Year||10.34%||10.34%|
|BBgBarc US MBS (Mortgage-backed)||2.82%||2.82%|
|BBgBarc US Corporate Invest Grade||-3.63%||-3.63%|
|BBgBarc US Corporate High Yield||-12.68%||-12.68%|
2nd Quarter Market Outlook
At the beginning of 2020, market fundamentals were arguably as positive as they had been in years. Interest rates were low, the labor market was historically strong, the U.S. and China achieved a potentially lasting truce in the long-standing trade war, and the global economy was showing signs of acceleration following a sluggish 2019.
But all that was upended by the coronavirus, which not only caused historic and unsettling volatility across global financial markets, but also upended normal society in a way none of us have ever seen before. Across the nation, and the world, roads are mostly empty, office buildings are vacant, schools are closed and normal life as we have known it has largely ground to a halt.
As we begin the second quarter of 2020, our investment approach is one of both caution as well as opportunity. While we’ve seen a nice rally off the recent low hit on March 23rd, we are technically now in a bear market and bear market rallies as we have just seen are very common. We will soon kick of the next set of quarterly earnings announcements which could be marked with many disappointments. The virus has not subsided. The stimulus package has been passed but a smooth and successful implementation remains to be seen and will likely face many difficulties. We are encouraged by the quick actions taken by Congress and the Fed and are still optimistic that things will look better a year from now. But in the short term we expect more volatility as we get both negative headlines as well as positive developments in the battle against the pandemic.
It is important to point out that, as Fed Chair Powell stated in a recent interview, there was nothing “wrong” with our economy before the coronavirus hit. There was no tech stock bubble and no housing bubble, like we saw in the last two U.S. recessions. As mentioned, economic fundamentals were rather positive prior to this unprecedented shock, and that offers some comfort when we look at investing over a longer time horizon.
To that point, it is also important to remember that this unprecedented market volatility, along with these societal disruptions, are temporary. At some point, the spread of the virus will peak and begin to recede
We are strong believers in the US economy. As the virus subsides and we begin to return to our pre-virus routines, economic activity will ramp up quickly. It may take a while to get back to the levels seen at the start of the year, but the markets are leading indicators and they have the potential to recover much quicker than many people would expect. High volatility and big sell-offs are an opportunity to invest in great companies seeing temporary setbacks and overly depressed valuations.
Shares of some of the most-profitable, well-run companies in the world are now trading at substantial discounts to levels at the beginning of the year, and history has shown us that over the longer term, these tumultuous episodes can create fantastic investment opportunities, and some of the most ideal buying conditions the market can offer.
Over the past month, we have all witnessed a degree of panic, both in regular society as well as in the financial markets. But as we all know, the worst thing to do during a panic is to panic. That’s because panic leads to hasty, short-term decisions that jeopardize your long-term best interests. Past performance is not indicative of future results, but history has shown that a long-term approach combined with a well-designed and well-executed investment strategy can overcome periods of heightened volatility, market corrections, and even bear markets.
We understand that volatile markets are both unnerving and stressful, and we thank you for your ongoing confidence and trust. Rest assured that our entire team will remain dedicated to helping you successfully navigate this difficult market environment.
Finally, above all else, please be careful and stay healthy.
James A. Betzig
Partner, Chief Executive Officer
Managing Partner, Senior Wealth Advisor
Partner, Senior Wealth Advisor
W. Michael Smiley
Partner, Head of Business Development
This material prepared by TrinityPoint Wealth is for informational purposes only. Additional data provided by Kinsale Trading LLC. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Opinions expressed by TrinityPoint Wealth are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. TrinityPoint Wealth, however, cannot guarantee the accuracy or completeness of such information, and certain information may have been condensed or summarized from its original source. TrinityPoint and Kinsale Trading LLC are not affiliated.