The first quarter of 2020 was one for the history books. Over the course of three months, the coronavirus known as COVID-19 transformed from a strange new virus in a faraway place to an imminent and deadly threat within our communities. The impact of the virus has been tragic for many.
In addition to the human toll, the economic fallout from the coronavirus has been severe as social distancing measures have essentially shut down substantial segments of the economy, forcing many businesses to close and lay off employees. In response to the economic shock, the U.S. government passed the largest fiscal stimulus package ever in March. The CARES Act earmarked $2 trillion to help large companies, small businesses and individuals navigate the economic strains. The Federal Reserve also took extraordinary measures, lowering short-term interest rates back down to 0%, backstopping money market funds, resuming its previous quantitative easing program (QE) and expanding QE to include both corporate and municipal bonds.
Stock markets around the world declined sharply in response to the economic turmoil and expectations that the virus will trigger a global recession. U.S. stocks, as measured by the S&P 500, registered their worst quarter since the fourth quarter of 20081, declining 19.6%. The MSCI ACWI ex US Index (a broad index of developed and emerging country foreign stocks) declined 23.4% during the quarter.
While all stock sectors in the U.S. registered losses in the first quarter, large-company technology stocks generally held up better than other market sectors. A handful of technology stocks even generated gains for the quarter as demand for their services increased – Zoom Communications, a videoconferencing company, saw its stock more than double as businesses scrambled to transition to virtual meetings. On the other end of the stock spectrum, value stocks and small company stocks lagged the overall stock market during the quarter. The relative performance of these stock sectors contrasted with 2008, the worst year of the previous bear market. In that year, both value and small company stocks modestly outperformed the broad market while technology stocks were one of the worst-performing sectors.2
High-quality bonds held their value during the quarter as the yield on the 10-year Treasury note declined to all-time lows. The bond portfolios we recommend for our clients generated flat to slightly positive returns, helping to moderate the impact of stock losses on portfolio values. Our focus on the high-quality end of the bond spectrum helped as lower quality (junk) bonds registered double-digit losses during the quarter.3
Looking across our clients’ portfolios, the variation in returns was largely a function of the amount allocated to stocks – portfolios with higher stock allocations incurred larger losses while those with lower stock allocations registered smaller losses.
Investment Strategy in the Face of Great Uncertainty
With the lack of any useful historical precedent and in the face of great uncertainty, forecasters’ estimates of the coronavirus’s impact on the economy and the stock market vary widely. The range of potential outcomes is wider than at any time since at least the financial crisis of 2008-2009.
As of this writing (April 9th), the U.S. stock market has rebounded off its low in March although it is still well below its high in February. Over the past week or so, some investment commentators have been encouraging investors to buy stocks at these lower levels. For example, a recent Wall Street Journal article titled, “It’s a Good Time to Stock Up” written by Burton Malkiel, author of A Random Walk Down Wall Street, makes this point.
In his article, Malkiel outlines some good reasons to buy stocks at the present time. For one, the sharp decline has caused investors’ stock allocations to drop below their long-term targets and one way to get back to these long-term targets is to rebalance portfolios by selling bonds and buying stocks. Moreover, given that prices are down, investors buying at current levels should expect higher long-term returns relative to the returns implied by stock prices a couple of months ago. Additionally, stocks tend to rise swiftly coming out of bear markets so a disciplined strategy of averaging-in ensures that investors captures at least some of these gains with their new purchases.
In our view, Malkiel’s advice is appropriate for some investors but not appropriate for others. The key determining factor is the investor’s ability and willingness to withstand additional stock market declines. A simple way to frame this issue is to consider how you would handle an additional 50% decline in stocks from current levels. While we don’t believe a further 50% decline in stocks is likely, it is certainly possible – a loss of this magnitude would result in a cumulative decline from the February high of about 60%, which would approximate the U.S. stock market decline during the financial crisis of 2008-09.
If an additional 50% stock decline is unlikely to affect your investment approach or to force you to substantially change your spending plans, buying stocks at this time via an averaging-in strategy could well make sense for you. In general, investors in this category tend to have longer time horizons, the ability to tap other assets for spending needs, and the ability to emotionally accept significant investment losses.
Ultimately, whether an investor should buy stocks at this time is highly dependent on each investor’s unique circumstances. What makes good sense for one investor may be inadvisable for another. In our role as advisors to our clients, we put a great deal of emphasis on understanding each client’s broader financial picture including their long-term objectives and preferences. With an understanding of the broader picture, we are well-positioned to help our clients make important financial decisions such as whether to buy stocks in a way that fits with their most important goals.
1. Source: Morningstar. The S&P 500 returned -21.95% during the 4th quarter of 2008
2. Source: Morningstar. Calendar year 2008 returns: S&P 500: -37.00%, Russell 1000 Value Index: -36.85%, Russell 2000 Index: -33.79%, S&P 500 Information Technology Sector Index: -43.14% (3rd worst of 10 sectors)
3. Source: Morningstar. The Barclays High Yield Corporate Bond Index returned -12.68% in the first quarter of 2020
Written by Rich Golinski, CFA, Chief Investment Officer; rich.[email protected]
|Index4||Market||12/31/19 – 3/31/20|
|Standard & Poor’s 500||Large Co. U.S. Stocks||-19.60%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||-26.73%|
|Russell 2000||Small Co. U.S. Stocks||-30.61%|
|MSCI All-Country World ex U.S.||Foreign Stocks||-23.36%|
|Barclays 1-5 Year Gov’t/Credit||U.S. Shorter-Term Taxable Bonds||2.17%|
|Barclays Aggregate Bond||U.S. Taxable Bonds (Broad-based)||3.15%|
|Barclays 1-5 Year Muni Bond||U.S. Shorter-Term Tax Exempt Bonds||-0.41%|
|JPMorgan Global Ex-U.S. Bonds||Hedged Foreign Bonds||1.45%|
Key economic indicators compiled by Jeffrey Blanchard, CFA, Director of Research; [email protected]
4. Index Glossary:
Standard & Poor’s 500: A market capitalization-weighted index that generally contains the 500 largest publicly traded stocks in the U.S., subject to certain restrictions. The index includes the reinvestment of dividends. An index is unmanaged and not available for direct investment.
Russell 1000 Value Index: A market capitalization-weighted index composed of constituents in the Russell 1000 Index with low price to book ratios and lower forecasted growth rates. An index is unmanaged and not available for direct investment.
Russell 2000 Index: A market capitalization-weighted index of U.S. small cap stocks that consists of the 2,000 smallest publicly traded stocks in the Russell 3000 Index. An index is unmanaged and not available for direct investment.
MSCI All-Country World ex U.S.: A market capitalization-weighted index that captures large and midcap companies in developed and emerging market countries excluding the U.S. An index is unmanaged and not available for direct investment.
Barclays 1-5 Year Gov’t/Credit: A broad-based bond index that measures the non-securitized component of the US Aggregate Bond Index and targets bonds with maturities between 1 and 5 years. An index is unmanaged and not available for direct investment.
Barclays Aggregate Bond: A broad-based bond index that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government agency bonds, corporate bonds and securitized fixed income securities. An index is unmanaged and not available for direct investment.
Barclays 1-5 Year Muni Bond: An Index that covers the USD-denominated tax exempt bond market with maturities of 1-5 years. The index includes state and local general obligation bonds, revenue bonds, insured and prerefunded bonds. An index is unmanaged and not available for direct investment.
JPMorgan Global Ex-U.S. Bonds: An index constructed of government bonds issued from developed countries outside the U.S. with the currency exposure hedged backed to the U.S. dollar. An index is unmanaged and not available for direct investment.
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