1Q 2020 Market Summary
Market prognosticators will attempt to predict the exact timing and speed of a market and economic rebound, using buzz phrases like V-shaped, U-shaped, or L-shaped curves to describe what a recovery may look like. While it is impossible to say exactly when that will be or what it will look like, it is possible to focus on investments that have the time frame to get there and the robustness to survive a wide variety of future scenarios. At Mesirow, we spend less time predicting the timing of a recovery and instead focus on the types of businesses in which we invest. We recognize that the economic impact from the spread of COVID-19 is very real, and the struggles some companies will face warrant lower stock prices; however, this doesn’t apply to all businesses.
The capital markets ended 2019 on a positive note, with most key sectors and asset classes posting positive returns during the fourth quarter. The S&P 500 Index returned an impressive 9.1% during the quarter, resulting in a total return of 31.5% during the full year 2019. The healthcare and technology sectors were the leading contributors to the strong S&P 500 during the quarter, as those sectors each rose 14.4%. For the year, technology stocks returned a staggering 50%. Utilities barely squeaked out a positive return of 0.8% during the quarter, while real estate stocks lost 0.5% during the quarter, as rising interest rates hurt both rate-sensitive sectors.
At a high level we view most companies as fitting broadly into one of three categories:
- The first group of companies carry sizable debt loads and are caught in the crosshairs of the COVID-19 related slowdown. These firms will struggle the most.
- The second group of companies will see a short-term shock to profits, but maintain healthy balance sheets that will help drive an ultimate recovery. Their strong balance sheets may also allow them to pick up assets and talented employees from companies that struggle to make it through.
- The third group includes companies that aren’t materially impacted by the slowdown, and in some cases, may benefit from new opportunities that arise.
With comfort that our clients are largely invested in businesses that will weather the current storm, we encourage investors to think about the recent volatility in the context of long-term business activity.
Concerns about the impact of the COVID-19 virus dominated the market during the first quarter of 2020. After closing at an all-time high on February 19, the S&P 500 Index saw a precipitous decline through the end of the quarter. Manic trading took control during the last six weeks of the quarter, with the index experiencing a drawdown of over -33% from the market high, ending the quarter with a -19.6% loss.
The -19.6% drop of the S&P 500 Index masks the severity of the stock market decline in the first quarter. Mid and small cap stocks fell more significantly, with the Russell Midcap Index and Russell 2000 Index declining -27.1% and -30.6%, respectively. It should be noted that the performance of the average stock in the S&P 500 Index fell -26.6%. Adding to the stress was a battle between Russia and Saudi Arabia over oil output (and thus prices), which sent the energy sector into a tailspin. For the quarter, the S&P 500 energy sector declined almost -51%, the worst of the 11 primary sectors. The remaining sectors fell between -32% (financials) and -12% (technology).
Fear over the potential impact of the virus roiled international equity markets as well. The MSCI EAFE Index fell -22.8% during the quarter, while the MSCI Emerging Markets Index dropped -23.6%. While the market sell-off was broad-based and mostly unexpected, some common themes from the past several years persisted:
- U.S. stocks outperformed non-U.S. stocks.
- Large companies outpaced small companies.
- Growth stocks trounced value stocks.
In fact, through the end of the first quarter, large cap U.S. equities are one of the only asset classes to still show positive returns over the trailing three-year period. Non-U.S. stocks, small capitalization stocks, and value stocks have all experienced negative total returns over the last three years through March 31, 2020.
Bond markets were not immune to the concerns caused by the spread of the virus either. Some areas of the bond market showed significant signs of dislocation due to a race to cash, panic selling, increasingly illiquid trading markets, and concerns over credit quality.
The Federal Reserve announced crisis-era steps to stabilize markets in response to these issues. These steps included massive purchases of Treasury bonds and agency mortgage-backed securities along with programs to provide funding and a back-stop for asset-backed securities, commercial paper and money markets, and even certain corporate bonds and corporate bond ETFs. Congress also passed a massive $2.2 trillion stimulus package that provides support for businesses, individuals, and families directly impacted by the COVID-19 response.
As a reference, the government’s rescue package during the Financial Crisis of 2007-2008, the Troubled Asset Relief Program (TARP), was $700 billion. Treasury yields plunged during the quarter as investors flocked to safe assets. Short-term bond yields fell the most during the quarter as the Federal Reserve made two rounds of emergency rate cuts, resulting in the Fed Funds rate falling back to the zero-bound range and one-year Treasuries falling 1.43% to end the quarter at 0.12%. The 10-year Treasury yield fell from 1.92% to start the year at an all-time low of 0.31% on March 9, before ending the quarter at 0.67%. Longer-term rates also fell as the 30-year Treasury yield ended the quarter at 1.33%, compared to 2.39% to start the year.
With the backdrop of falling interest rates and concerns over the depth and length of a recession, safer government securities held up well, while corporate bonds declined in value. The Bloomberg Barclays U.S. Aggregate Bond Index returned 3.2% in the first quarter, while the Bloomberg Barclays U.S. Corporate Investment Grade Index fell -3.6%. Below-investment grade (also known as high yield bonds) fell an equity-like -12.7% as high yield spreads widened from 336 basis points to start the year to 880 basis points over Treasuries as of March 31, 2020.
The Bloomberg Commodity Index fell -23.3% in the first three months of 2020, in large part due to plunging oil prices. The price of a barrel of WTI Intermediate Crude oil fell -55% to $20 per barrel, an 18-year low. Gold prices held up relatively well with the LBMA Gold Price index generating a positive return of 5.4% during the 1Q.