The Markets	03/31/20 Close	12/31/19 Close	1st Qtr. Change	03/31/19 Close	12 Mo. Change	YTD Change
Dow	21,917	28,538	-23.20%	25,929	-15.47%	-15.47%
NASDAQ	7,700	8,973	-14.19%	7,729	-0.38%	-0.38%
S&P 500	2,585	3,231	-20.00%	2,834	-8.79%	-8.79%
MSCI EAFE	1,560	2,037	-23.42%	1,875	-16.80%	-16.80%
10-yr Treas. yield	0.70%	1.92%	-1.22%	2.41%	-1.71%	-1.71%
Fed funds rate	0 – 0.25%	1.5-1.75%	-1.50%	2.25 – 2.5%	-2.25%	-2.25%

(stock indices are before dividends; yield and rate changes are absolute changes)

The quarter began innocently enough, with mixed data (see a brief summary below) and then came March and all bets were off. Over the weekend of March 7, Russia and Saudi Arabia entered a full-fledged price war on oil, with the price falling 35% on March 9. That impact was amplified by the growing recognition that COVID-19 was going to be a big problem here in the US.  Over the next two weeks there were three trading days when stock market “circuit breakers” kicked in for a 15-minute close to trading, the stock market went from peak to bear market in record time, there were five days with moves of 2,000 points or more for the Dow, and twice the market had the biggest one-day drop since 1987 (with the biggest one-day increase since 1933 thrown in for good measure). Ultimately the US stock market suffered its worst quarter in 12 years.

Through it all, of course, the market was not the biggest news, as the virus flared up and New York City become the US epicenter. And from a pure investment perspective, the 12-month performance figures really weren’t that bad by the end of the quarter (the Dow suffering more from energy exposure). Treasury securities and gold were the only major categories to end the quarter in positive territory while low-quality investments were especially hard hit.

The US government shifted from all but dismissing the virus to banning travel from Europe and closing both borders for nonessential traffic, taking significant measures to support the health care system, implementing widespread social distancing through April and eventually passing a $2.2 trillion relief package that will supplement unemployment benefits, make payments directly to taxpayers and provide relief and support to a number of key industries.  Oil eventually fell below $25, a 66% fall, with gasoline at $1 in some pockets as demand collapsed as well. The first “virus jobs loss report” showed 3.3 million claims for the week ending March 21 (for comparison, there were 2 million claims for the first four weeks of the Great Recession.)  Unemployment will likely spike from 3.5% in February to as much as 10% or more before the crisis ends.

The Fed was extremely active and decisive, leaving no doubt as to their intention to do whatever it takes to prop up the economy. The rate on the benchmark Treasury hit a then all-time low of 1.32% in late February and the Fed cut rates by 0.50% on March 3 as the virus picked up steam. (The benchmark rate went as low as 0.40% on March 9, recovered to 1.12% and closed the period at 0.70%.) In a rare Sunday meeting on March 15, the Fed then took rates all the way to zero, cutting the final 1% in one fell swoop. At the same time, the Fed injected $1,5 trillion into the market to maintain liquidity through loans to banks, announced they would back up money market funds to prevent loss or lack of access by investors, increased the purchase of Treasuries and agency securities and announced a “main street business” lending program similar to the Small Business administration.  This intervention extended across the fixed income market to include investment grade bonds, tax-exempt commercial paper and asset-backed securities.

(Here’s what happened in the first two months: oil hit an 8-month high, jobs for 2019 increased by over 2 million for the ninth straight year, home sales were strengthening with some easing of tight supply and low rates, the Fed left rates unchanged in January, GDP grew by 2.1% in the fourth quarter and by 2.3% for full-year 2019, Brexit became official with 11 months to work out the details and an agreement was reached to hopefully get all US troops out of Afghanistan in 14 months. Normally all this would be big news.)

Looking Forward 

It goes almost without saying that the depth and length of the economic slowdown related to the coronavirus will be critical.  Estimates range all over the map, as they always do, and some forecasters will claim genius after the fact, as they also always do.  The drop in GDP for the second quarter could be anywhere from less than 10% to well over 20%, depending on when most businesses can return to “normal”, whatever the new normal may look like after the first round of the virus.

In addition to the immediate impact, it is not clear whether the virus will return in the fall and whether it will become part of the annual flu season.  (And over the last several years, the flu season has been extended and now goes well into July.)

Aside from those big unknowns, there are some components of the eventual recovery that could range widely and have a significant impact.  One is the pace of jobs being restored at pre-virus wages and activity levels.  Some of the jobs recovery could be slowed by cultural changes following months of social distancing and changes in routine, while many businesses may just not be able to rapidly resume.  The stimulus package will help both businesses and workers to some extent, but it is unlikely that there will not be some degree of lingering damage to jobs.

Another wild card is to what extent the public holds lingering fear and anxiety from the devastating impact of COVID-19. Supply can only do so much, and demand will have to show an equal if not faster revival. And if the virus rears its ugly head again in the fall or winter and we have anywhere near the reports of shortages, crisis and potential spread we have now, all bets will be off again.

This crisis is undeniably different that a natural disaster or even the threat of a terrorist attack.  It is truly unprecedented since the Spanish flu in 1918 and the same community resolve that it takes to end the spread of the virus will be needed to restore the economy, for the good of everyone.

Our Portfolios

To answer the big questions – no, we did not anticipate the market decline; no, we did not make portfolio adjustments at any point while the market was in total disarray; yes, we advocate staying the course for the long term.  None of these answers should be any surprise given our approach to portfolio construction and management.

That does not mean that our approach leaves our portfolios fully exposed to the volatility of the markets.  Our disciplined approach is designed to make incremental adjustments along the way after identifying the appropriate allocation in the first place.  Simply put, our balanced portfolios suffer nowhere the damage of the stock market headlines.

The market decline, following years of positive performance, offers an excellent illustration of how this discipline benefits our portfolios.  Through managing cash inflows and outflows, and by periodically rebalancing, we have been selling the assets which have appreciated more than other areas and adding to the areas that have lagged. This means we have been incrementally selling US stocks over time and adding to the fixed income allocation, which left the portfolios in better position to weather the downturn and benefit from the ballast provided by fixed income.

Likewise, for those portfolios which have ongoing withdrawals, we will not be selling stocks into a weak market but will reduce the stronger fixed income holdings as necessary.  This process is supported by our “cash rules’ for each client, which restore cash holdings on an ongoing basis to fund withdrawals and which are independent of market conditions.

Over the last several years we have reduced and, in most cases, eliminated high yield bond exposure.  This was not a market timing exercise but was rather a recognition that even when high yield bonds were performing well, they did not add to the risk/return exposure of the portfolio.  From experience we knew that if things turned south, high yield bonds would suffer in the flight to quality, so if there was no positive benefit and a known negative consequence, we chose to exit well in advance of a downturn.

The stock market slide has also created an opportunity to take some tax losses, which can be carried forward and offset subsequent capital gains.  When taking losses, we generally prefer to maintain market exposure by buying a similar investment (and the costs of transactions being drastically reduced or even eliminated makes this even easier) rather than adding significantly to cash; markets can turn quickly and we do not want to risk missing that turn.  If the market continues to decline, then there may be other losses to take and return to the original holdings at lower prices.

These incremental adjustments don’t have the drama of big portfolio changes, but in our opinion they are more effective at riding out market volatility and supporting our clients’ goals. 

The Worst Form of an Economy Except For All the Others That Have Been Tried?

That is a paraphrase of Churchill’s famous quote regarding forms of government, but it used here to refer to our old friend, capitalism.  While some staunch capitalists won’t accept one bit of criticism, most people would acknowledge problems but ultimately conclude it is a system worth nurturing and keeping.

Or maybe not.  This is from an article posted on Yahoo Finance in January 2020:

Most people believe that modern day capitalism “does more harm than good in the world,” according to a new survey.

The closely-followed 20th annual Edelman Trust Barometer — an annual survey of 34,000 people across 28 countries that measures the public’s trust in NGOs, business, government, and media — underscored how a strong global economy and a booming stock market have failed to completely allay the public’s worries about their own economic prospects.

Edelman released the survey timed to the 50th annual World Economic Forum in Davos, Switzerland. This year’s forum centers around the idea of stakeholder capitalism, proclaiming that a company’s purpose goes beyond generating wealth and instead should be measured by its environmental, social, and good governance objectives.

According to Edelman, 56% of respondents question capitalism as it exists today. The survey also found that 78% of respondents agreed with the statement that “regular people struggle just to pay their bills as elites get richer than they deserve.”

A whopping 83% also indicated concerns about losing their jobs for various reasons like a weak economy, lack of job security, automation, or a lack of skills. Meanwhile, 62% felt work technology was “out of control,” and technological change was happening too quickly.

Elsewhere, this year’s barometer showed a growing trust inequality amongst countries. Interestingly, the wealthiest nations are among those seeing the most considerable decline in trust among its NGOs, business, government, and media.

In addition, the Business Roundtable signed a letter last year that moved away from the idea of shareholder primacy — and redefined the purpose of a corporation as one that should serve all stakeholders, from its customers, employees, suppliers, communities, and shareholders.

The survey’s respondents did recognize the critical role businesses can play in creating change. Three-quarters of those surveyed believe that a company can “can take actions that increase profits and improve the conditions in communities where it operates.”

Hopefully we will start to see real efforts to improve the system before just throwing it out.