March 10, 2020

Monthly Market Summary – February 2020

How quickly things change.  Early in February, U.S. and European stock indices hit new record highs on reports showing manufacturing picking-up, better than expected earnings, and, in the U.S., a jump in the number of new jobs.  Announcements that China cut tariffs on $75 billion of U.S. imports as part of the Phase One trade deal and increased economic stimulus measures to offset the impact of the Coronavirus (COVID-19) outbreak also provided a boost to equity markets.  However, after reaching a peak on February 19, equity markets experienced a rapid and sharp decline through the end of the month.  Major stock indices entered correction territory during the last days of the month, which means a decline of over 10% but less than 20% from a recent peak.  As of February 28, the S&P 500 and pan-European STOXX 600 indices were down 13% from their peaks.  The selling was broad based across all industry sectors.  Commodity markets sold-off as well.  For example, West Texas Intermediate (WTI) crude oil fell 16% between February 19 and 28.  As so often happens during risk asset sell-offs, safe haven assets such as government bonds rallied.  The benchmark 10-year U.S. Treasury bond yield dropped (and price rose) to an all-time low of 1.13% on February 28.  The 30-year Treasury bond yield dropped below 2% for the first time on record and ended February at 1.65%.

Fears about the COVID-19 and its potential economic impact shocked investor sentiment and drove the global sell-off.  In attempts to contain the virus, travel and trade throughout China has been restricted leading to permanent loss of business for certain companies, temporary loss of business that could be recouped later in the year for other companies, and disruptions to the supply chain for businesses around the world.  As reports came out of new cases of people infected with the virus in the Middle East, Europe, South America, and the U.S., worries about the negative economic impact spreading beyond China and about the severity of the impact increased.  As a result, market participants increasingly moved out of risk assets, such as equities, and into safe haven assets such as government bonds and cash.  The heightened demand for government bonds drove yields lower, which triggered program trading selling, which drove equity prices even lower.

All major U.S. equity market indices posted large negative returns for February.  There was little difference between the returns for the large-capitalization (cap), mid-cap, and small-cap indices with each down over 8%.  Growth stocks declined less than value stocks.  Returns were negative for each of the 11 industry sectors.  Energy had the lowest return across each market cap category on worries about shrinking demand.  Healthcare and communication services were the best performing sectors but still had large declines for the month.

Both the MSCI EAFE index of developed international country equities and the MSCI Emerging Markets index (EM) had a negative return for the month.  The EM index was the performance leader with a return of -5.3%, which outperformed the EAFE and U.S. equity indices.  U.S. dollar based returns from both the EAFE and EM indices were lower than the local currency returns since the dollar rose to a three-year high early in the month before falling in the sell-off in the second half.  Just as in the U.S., growth stocks outperformed value stocks in both the EAFE and EM indices.  Sector returns were also similar with all sectors posting a negative return and energy declining the most.  Healthcare, information technology, and communication services had the smallest declines.  On a geographical basis, China had the best return followed by certain other Asian countries such as Taiwan.  In emerging markets, Latin America was the poorest performing region led by double-digit gains for Brazil, Chile, and Mexico.  Among developed international countries, Australia, Japan, and the United Kingdom had the largest declines.

U.S. bond market sector returns were mostly positive in February.  Corporate high yield bonds was the only fixed income sector to post a negative return for the month.  Energy company bonds make up a large portion of the high yield sector and the energy sector has been severely pressured by the drop in oil and natural gas prices.  Treasury bonds outperformed corporate, municipal, and mortgage-backed bonds on the flight to safety trading.  Longer maturity bonds outperformed shorter maturity bonds.

The Bloomberg Commodity index declined 5% for the month of February.  Returns were negative for each of the sub-indices we track.  The petroleum sub-index had the worst return hurt by lower oil prices.  The price of WTI crude dropped below $50 per barrel during February and was as low as $46.76 at the end of the month.  The livestock sub-index was another of the weakest sectors.  The precious metals sub-index had one of the smallest negative returns for the month since the price of gold rose to a multi-year high early in the month before experiencing a sharp drop late in the month.

Vogel Consulting, LLC (Vogel) Tactical Recommendations

It is too early to tell what the ultimate economic impact of COVID-19 will be as the situation is changing daily.  While the number of new cases outside of China is likely to continue to increase in the coming days, the economic disruption is expected to be a short-term event since governments and medical professionals are working diligently to contain the spread of the virus.  In a bit of good news, in China where the outbreak began in December, the number of new cases has been declining for days and stores and factories are reopening.  Financial markets do not like uncertainty, which is leading to heightened volatility.  Even though monetary authorities around the world have announced they stand ready to take measures necessary to support their economies, it is likely that the high level of market volatility will continue until there is evidence the spread of the virus is stabilizing.

We continue to remind you that it is best to avoid emotional reactions during times of extreme volatility and to rather focus on long-term investment objectives.  We continue to monitor events and speak to various money managers about their assessment of market events and investment opportunities.  We have been recommending for quite some time that families keep at least a year of cash on hand to be in a position to ride out market volatility.  Our asset allocation recommendations have not changed.  With bonds looking expensive with yields at historic lows, we favor equities over bonds.  We expect the impact of the COVID-19 outbreak to be short-term.  However, other sources of potential volatility remain, such as the election campaigning in the U.S.  Therefore, we continue to recommend holding enough cash reserves to support spending needs for at least the coming 12 months.  Within the equity allocation, we recommend an equal weight position relative to long-term targets to U.S. large-cap, mid-cap, and small-cap stocks, as well as to developed international and emerging markets equities.  Within our fixed income recommendation, we continue to favor short to intermediate maturities.  We continue to recommend an underweight allocation to hedge funds.

The statistical information contained in this commentary has been compiled from publicly available sources and is presented to you for your review and for discussion purposes only. The information contained in this commentary represents the opinion of the author(s) as of its date and is subject to change at any time due to market or economic conditions.  These comments do not constitute a recommendation to purchase, sell or hold any security, and should not be construed as investment advice or to predict future performance.  Past performance does not guarantee future results.

The statistical information contained in this commentary was derived from sources that Vogel Consulting, LLC believes are reliable, and such information has not been independently verified by Vogel.  Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Russell Investment Group.  An index is not managed and is unavailable for direct investment.