Q1 2020 Market Commentary – April 10, 2020
Looking back at our last quarterly report feels like reading a report from many years ago. There was no hint of COVID-19, and we had just finished a year in which the US stock market rose by 31% (as measured by the S&P 500). Three months later, the world economy has pushed the “pause” button, and the S&P 500 has declined by 20% in the first quarter.
The concern is not so much a few months of lost activity, but rather whether COVID-19 will precipitate a longer-term recession as the economy tries to resume after it passes. The longer the virus drags on, the longer the recovery is likely to take. The US government, and governments around the world, have aggressively used both fiscal measures (stimulus programs) and monetary measures (central bank actions) to buffer the impact on the economy, both of which seem to have had positive effects so far in keeping the economic systems functioning.
The other question is how long it will take the stock market to regain its previous high. We published a short paper on our web site recently titled “Recovery Periods Following Major Market Declines”, which shows that the length of time for recovery is closely related to the severity of the decline. Plotting the current 34% maximum decline (so far) onto the historical averages suggests it could take about two and a half years for the market to regain previous highs.
Markets started the year confidently, and stocks continued to increase even after the coronavirus started to spread in Asia, as many market participants compared it to earlier epidemics that failed to spread globally. By February 19th, US large company stocks, as measured by the Russell 1000, had risen 5.4%. However, shortly after the first case of the new virus appeared in Europe, markets started to fall dramatically, with the Russell 1000 reaching a low on March 23rd, down over 31% on the year before coming back to end the quarter down just over 20%.
Even with a 20% decline, the Russell 1000 index of US large cap stocks outperformed other major stock indexes. US small cap stocks, as measured by the Russell 2000, fell 31% amid concerns that some smaller enterprises might not have the resources to maintain operations through the downturn. Foreign developed stocks fell 23%, slightly more than US stocks, and emerging markets declined 24%, initially falling more than developed markets, as China was the first country to be impacted, but then falling less, as China recovered and the virus moved on to the Europe and the US.
The Federal Reserve reduced its benchmark rate to zero during the quarter in order to help buffer the economy from the negative impacts of the coronavirus. It also started aggressive programs of buying bonds and used its emergency authority to set up a vehicle for lending directly to businesses, via the commercial paper market, for the first time since the financial crisis of 2007-2009.
For the quarter, the 10-year interest rate declined from 1.9% at the beginning of the year to 0.7% at the end of March. As bond rates decline, the price of existing bonds rises, and the Bloomberg Barclays US Aggregate Bond index gained 3.1% for the year so far. Global bonds, TIPS, and short term bonds all gained in value as well, albeit to a lesser extent.
Commodities and Currencies
The extremely low price of oil caused significant concern in the markets toward the end of the quarter. Energy prices started the year at $61 per barrel (WTI crude price) and ended the quarter at $14 amid a price war between Russia and OPEC, and plummeting demand due to COVID-19.
Gold rose fairly steadily throughout the year. It added 6.2% in the first quarter, as market participants sought the safety of gold, bonds, and cash. The dollar has stayed strong in 2020, also as part of the market’s effort to find safety.
One thing we pointed out last quarter was that a diversified portfolio would help to mitigate both visible and not-yet-visible risks. We certainly got hit by a “not yet visible” risk this quarter, but balanced portfolios held up well, and bond and gold positions in portfolios provided a degree of counterweight to the stock positions.
In our article “Recovery Periods Following Major Market Declines” that was mentioned in the introduction to this quarterly update, we point out that balanced portfolios have rebounded more quickly than the S&P 500 from market declines. In the financial crisis of 2007-2009 the S&P 500 lost as much as 51% at the worst point, and took 4.4 years to recover its previous high (based on month-end data). In that crisis, a 60/40 diversified portfolio would have fallen 30% and had a more modest recovery time frame of 2.9 years.*
While we may not be able to predict the future better than other market participants, we are confident that in the long run we will look back at the COVID-19-induced crash as just another of a long line of market ups and downs. Investors are compensated for taking on this kind of risk, and long-run returns will benefit not only from holding fast during this turbulent period, but also from rebalancing accounts while there is fear in the market. Plum Street Advisors continues to focus on the long-term returns of our clients, while emphasizing a well-planned strategic allocation that targets a level of market volatility appropriate for each client.