April 09, 2020

Monthly Market Summary – March 2020

March was an historic month in many ways due mostly to the COVID-19 virus outbreak which the World Health Organization classified as a pandemic during the month, but also due to the Saudi Arabia-Russia oil price war.  Fear of the COVID-19 virus spreading brought about drastic social distancing measures and government mandated shutdowns of economic and social activity around the world.  This created an immediate demand shock and a liquidity crisis.  Businesses, individuals, and governments scrambled to find enough liquidity to remain afloat through the pandemic shutdowns.  The demand shock flight to safety and the need to find liquidity wherever possible led to rampant selling of assets, even for a time, assets generally considered to be safe havens.  The seizing up of credit markets in the rush to reduce leverage scared the equity markets which pushed prices even lower until the Federal Reserve (Fed) announced multiple programs to essentially backstop all types of money market and fixed income securities.  The financial markets also were stung by the outbreak of an oil price war between Saudi Arabia and Russia after the previous production cut agreement fell apart.  Both countries announced they would ramp up production in an attempt to gain market share.  Oil prices crashed to multi-year lows and set-off worries about a surge in loan defaults and bankruptcies across the energy sector, and dividend cuts for even the largest multi-national energy companies.

Volatility across asset classes was extreme in reaction to daily pandemic news and day-to-day changes in government and central bank policy responses.  The high level of uncertainty about the duration of the pandemic and the associated economic shutdowns and about the magnitude of the impact has limited market participants’ willingness to step in and buy assets even after the significant price pullbacks.

Asset returns and certain economic data in March were some of the weakest on record.  For example, new unemployment claims in the U.S. skyrocketed to 3.28 million in the report released March 26 reflecting the layoffs associated with the mandated shutdowns and shelter in place orders.  Likewise, new unemployment claims in Canada hit one million in the same week.  The 10-year U.S. Treasury bond yield dropped below 1% for the first time on March 3.  A few days later the 30-year U.S. Treasury bond yield also fell below 1%, bringing the entire U.S. yield curve below 1% for the first time in history.  Stock indices set records, such as the STOXX Europe 600 index having its worst one-day performance on record with a drop of 11.5% on March 12 and the Dow Jones Industrial Average (DJIA) having its largest one-day drop of 12.9% on March 16.  Interestingly, the DJIA had it largest one-day gain on record of 11.4% on March 24.  Equity indices experienced the fastest onset of a bear market (a decline of 20% or more from the recent peak) in history in March.  For example, the S&P 500 and Nasdaq sank into a bear market on March 12 just 16 trading days after hitting record highs.

The 11-year bull market for U.S. equity markets ended in March.  As noted above, the S&P 500 and Nasdaq indices each entered a bear market mid-month declining 20% from their February record highs.  The DJIA reached bear market territory a day earlier.  The indices continued to move lower.  The S&P 500 hit its low point of this draw down to date on March 23 with a decline of 34% from the February 19 peak.  The indices turned higher late in the month after the Federal Reserve announced a number of programs that will provide a backstop to money and credit markets and Congress passed a $2 trillion relief package aimed at providing income to individuals and business owners.

The major U.S. equity market indices posted large negative returns for March.  Large-capitalization (cap) stocks declined less than mid-cap stocks which declined less than small-cap stocks.  Growth stocks declined less than value stocks.  Returns were negative for each of the 11 industry sectors.  Healthcare, consumer staples, and utilities, were the best performing sectors with the smallest declines for the month due to the necessary nature of the goods and services provided from companies in those sectors.  Energy had by far the lowest return since the price of crude oil and natural gas dropped to multi-year lows due to shrinking demand and elevated supply.  Financials was another of the weakest performing sectors.  The sharp drop in interest rates and concerns about an uptick in loan defaults pressured financial company stocks.  The consumer discretionary sector in the mid and small-cap categories also posted one of the largest sector declines hurt by the significant drop in demand, which in some cases was as much as a complete shutdown of businesses, due to the social distancing, travel restrictions, and shelter in place orders.

Both the MSCI EAFE index of developed international country equities and the MSCI Emerging Markets index (EM) had a double-digit negative return for the month.  U.S. dollar based returns from both the EAFE and EM indices were lower than the local currency returns since the dollar rose.  Just as in the U.S., growth stocks outperformed value stocks by a wide margin 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, consumer staples, and communication services had the smallest declines.  On a geographical basis, China was the best performing among emerging markets with a single digit negative return.  COVID-19 related closures and restrictions were gradually lifted in China throughout the month with essentially all businesses, stores, and modes of transportation (with the exception of certain restrictions on international flights) operating again.  Other Asian regions, such as South Korean and Taiwan, where the virus has peaked and activity is resuming also had smaller negative returns than emerging European and Latin American markets.  Among developed international countries, Japan and Switzerland were the top performers with only single-digit negative returns, mostly due to their safe haven status.  Countries hit hardest by the virus including Italy and Spain had the largest negative returns among developed countries.  Australia was another of the weakest developed markets.

U.S. bond market sector returns were mixed in March.  The Treasury bond and mortgage-backed indices had positive returns for the month.  Treasury bonds rallied on flight to safety trading during most of the month driving yields to all-time lows.  The 3-month Treasury bill yield briefly turned negative.  The benchmark 10-year Treasury bond yield moved as low as 0.5% during the month on elevated demand.  As a reminder, the yield on the 3-month Treasury bill and the 10-year Treasury bond ended 2019 at 1.55% and 1.92% respectively.  Corporate and municipal bond indices had negative returns on a rush for liquidity and concerns about increasing defaults.  The corporate high yield bond index had the largest decline with a double-digit negative return.  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.  Corporate, mortgage-backed, and municipal bond markets calmed after the Fed announced a series of bond buying programs that included for the first time purchases of corporate bonds and corporate bond exchange traded funds.

The Bloomberg Commodity index declined over 12% for the month of March.  Returns were negative for each of the sub-indices we track.  The petroleum sub-index had the worst return hurt by the crash in oil prices brought on by the severe drop in demand and the Saudi-Russia price war.  The price of West Texas Intermediate crude dropped 60% to $20 per barrel during March.  The precious metals sub-index had one of the smallest negative returns for the month since the price of gold rose on safe haven trading.  The agriculture index had only a small negative return also even though the livestock sub-index declined about 13%.

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 with the virus and government and central bank policy responses is changing daily.  The ultimate question is how long do the economic shutdowns last.  That will determine how much damage is from delayed demand/revenue that will rebound when the growth rate of new virus infections turns negative, and how much is from permanent demand destruction leading to credit defaults, bankruptcies, and permanent business closures, and long-term high unemployment.  The experiences in China, South Korea, and Italy are giving some hope that the peak in new cases will come during the second quarter.  In a bit of good news, in China where the outbreak began in December, the number of new cases has fallen to single-digits per day and most stores, factories, and businesses reopened by the end of March.  However, China instituted harsher containment methods than have been used in most of the Western world.  In Italy, where cases were first reported at the beginning of February, the number of new cases appears to have peaked March 21.  Financial markets do not like uncertainty, which is leading to heightened volatility.  Even though monetary authorities and governments around the world have announced massive amounts of monetary and fiscal stimulus aimed at providing liquidity to support medical efforts, to backstop credit markets, and to provide income replacement for business and individuals as a bridge during the shutdowns, it is likely that the high level of market volatility will continue until there is evidence the spread of the virus has peaked and the growth rate of new cases turns negative, or safe ways for a return to work are identified through measures such as taking workers’ temperatures.

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.  Since financial markets tend to be forward looking and will likely bottom before the virus crisis does, we recommend focusing on thinking about what the economy and financial markets will look like on the other side of the COVID-19 induced valley and planning for any appropriate portfolio rebalancing.  We continue to recommend keeping at least a year of cash on hand to be in a position to ride out market volatility.  With bonds looking expensive with yields at historic lows, we favor equities over bonds.  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