Wow! What an epic period we just experienced! We recently saw the most volatile quarter ever in the history of the U.S. stock market. Volatility came screaming back into our lives after a relatively smooth and profitable year in 2019. We hope that everyone remains safe and secure while we are locked in due to the COVID-19 pandemic.
Markets in Q1
In last quarter’s letter, I discussed lessons learned from our past 20 years of experience in financial markets. Little did I know how timely this letter would turn out to be! The market was certainly experiencing some exuberance after the S&P 500 Index of U.S. Large Cap stocks had returned 31.49% in 2019. It was only to be expected that the market might give back some of its gains in 2020. Then, a disastrous chain of events occurred that shocked our entire way of life.
On January 3, President Trump authorized a drone attack on the Iranian general Qasem Soleimani, who had led terror attacks for decades. Five days later, the Iranians countered with a ballistic missile attack and, in the process, accidentally downed Ukraine International Airlines Flight 752 with the loss of all 176 onboard. On January 21, the U.S. Senate began the impeachment trial of President Trump in which he was eventually acquitted. To end the month of January, the United Kingdom officially terminated its membership in the European Union as it began the difficult process of BREXIT. During the problematic vote count of the Iowa Caucuses in February, the 2020 Presidential Election kicked off with 11 Democratic candidates seeking their party’s nomination to compete against the incumbent president.
Word soon came from China about a potentially threatening coronavirus that had forced the closure of Wuhan Province, thereby threatening the integrity of global supply chains. A further unraveling of stability created a toxic brew that instilled fear and panic among investors as they dumped shares of risky assets in the face of a rapidly deteriorating global economy. When prices started to waterfall in mid-February, banks and brokerage firms placed margin calls with large hedge funds and private equity firms that were then forced to sell their assets at any price they could find. Bond yields tumbled as investors sought the safe haven of Treasury bonds; at one point, even Treasuries received no bid from buyers as cash became the only asset class many investors were willing to hold overnight. The selling rose to a crescendo until March when the Federal Reserve intervened in the markets by resurrecting many of the programs that it had used during the Great Financial Crisis (GFC) of 2008. The Federal Reserve created a financial entity known as a Special Purpose Vehicle (SPV) designed to hold risky assets that market participants were forced to offload due to their need for cash.
To make matters even worse, the Saudis walked out of an OPEC+ meeting with Russia in a dispute over limiting crude oil production as both countries sought to squeeze American shale producers. This decision, combined with falling global demand, led to a glut of supply, which in turn crashed the price of oil and other commodities. On March 11, the World Health Organization declared COVID-19 a pandemic, and most nations responded by instituting quarantine or lock-down orders to restrict the unnecessary movement of people to combat the spread of the disease.
By March 20, the number of global cases of COVID-19 had exploded to over 250,000, with 10,000 deaths reported. Emergency measures were needed to keep the world from sliding into a Great Depression 2.0. On March 25, the U.S. Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to provide over $2 trillion in stimulus. The financial markets responded with a bang as a rally in stock prices developed largely due to central banker actions and governmental intervention to stem the loss of investor and household confidence with appropriate backstops. As of April 10, the total stimulus package is estimated to be on the order of $8 to $10 trillion, almost one half of the nation’s GDP.
What is the Future?
There is absolutely no one on the planet who could have forecasted this bizarre and tumultuous chain of events. I cannot imagine a more stressful environment for live-testing our investment philosophy. We design our portfolios with an “all weather” approach; we want them to survive anything that the market can throw at them. As of today, our financial plans and investment portfolios have survived one of the most challenging and demanding quarters in our country’s history.
If you are feeling a bit weary and overwhelmed by the speed and complexity of global events, you are in good company. No one knows what the future holds, but it is clear that a difficult recession is upon us. There are various estimates of how bad it will be or how long it will last. At Telarray, we are convinced the best approach is avoid trying to forecast the future but take control of what you can do to increase the odds of success in your favor. These principles are timeless and have worked in many types of economic environments. In fact, we have adopted these as our core principles:
- Experts and their forecasts are often not very useful.
- Markets generally do not like uncertainty; however, these periods of higher volatility can give investors some of the best times to put money to work.
- A long-term approach requires patience and skill to earn the rewards.
- Short-term market timing is very, very difficult to accomplish successfully.
- Cash management is key to your success.
- As much as the world changes, the fundamentals of investing remain the same.
- Adopt a strategy that you can stick with through good times and bad.
- Diversification keeps you from making a big mistake in your financial plan.
- Keeping your strategy as simple as possible makes it easier to implement, to monitor, and to revise as events dictate.
If you held your ground during the onslaught of events and you find your financial plans still intact, then give yourself a high five and a big pat on the back! Remember that we have tested your plan with your specific fact pattern over a wide variety of historical events. Now you can add the year of the Coronavirus 2020 to your list.
All equity classes were negative for the quarter and the year as the market rapidly repriced the cost of equity. The market was under intense selling pressure as investors sold everything to generate much needed cash. Despite the vicious nature of this market crash, the redeeming news is that we are seeing some really attractive valuations for the first time in many years, which should provide long-term investors an excellent opportunity to purchase bargains for their portfolios. Another source of some comfort is that ten-year performance numbers are still positive, and most ten-year cumulative numbers are still triple-digit. This is a crucial reminder to keep your focus on the long run!
In the short run, just about anything can, and will eventually, happen, so do not let this market selloff shake you out of your plan. There was really no place to hide in the stock market during this period, and this action explains why we press so hard on maintaining the proper mixture of cash and bonds to offset stocks when the market behaves like this.
Fixed Income Returns
Fixed income returns were much more encouraging, and they fulfilled their anticipated role as providers of safety and security during the rout in the equities market. Intermediate term taxable bonds were the top performer for the quarter and also for the year. investment grade bonds underperformed U.S. Treasuries due to higher credit risk. Bond yields are currently some of the lowest ever seen in U.S. history so we do not see much future return in these asset classes. However, we continue to recommend their use because they can dampen the volatility of the overall portfolio and provide much needed cash, so we do not have to sell stocks in a down market to meet your liquidity needs.