It’s actually hard to believe what happened in the first quarter due to the sheer speed of change. I have been in markets for 25 years and I can never remember anything like what occurred in the 1st quarter.
Today I thought it would be worth recapping what did actually occur in Q1 from a global perspective. The following information was provided by Morgan Stanley in New York and is a solid helicopter view of what unfolded.
US Quarterly (Q1 2020) Recap:
Dow (-23.20%), S&P (-20.00%), Nasdaq (-14.18%), Russell 2000 (-30.89%).
S&P 500 Sector Performance:
Outperformers: Tech (-12.22%), Healthcare (-13.07%), Consumer Spls. (-13.39%), Utilities (-14.19%), Communication Svcs. (-17.23%), REITs (-19.35%), Consumer Disc. (-19.59%)
Underperformers: Energy (-51.06%), Financials (-32.34%), Industrials (-27.41%), Materials (-26.60%)
US equities were down in Q1, falling into a bear market and ending a bull run that dated back to 2009. The S&P dropped 20%, logging its worst quarter since Q4’08. The index’s worst two days since 1987 came in mid-March (down 11.98% on 16-Mar, down 9.51% on 12-Mar). The S&P also saw two days of 9%+ gains (13 Mar, 24 March) in the extremely volatile March period.
Treasuries were notably stronger, with yields dropping to long-term lows and the curve steepening somewhat. The 30-year bond saw its yield drop below 1% on two trading days, opening the quarter at 2.39% and on 13-March touching 0.67%. The DXY dollar index rose 2.8% in Q1, with the dollar strengthening against the euro and pound, while lagging the risk-sensitive yen. The dynamic was driven by a broad-based liquidity grab amid concerns about paralysed businesses and solvency concerns, as well as the unwinding of leveraged trades. Gold was up 4.8% for the quarter, its sixth consecutive quarterly gain. Oil lost more than 66% — its worst quarterly performance ever — after the collapse of the OPEC+ output agreement and the demand shock from the expanding coronavirus pandemic.
All sectors were lower. Energy lagged amid the collapse in oil prices. Financials were hit by low rates. Industrials underperformed, with airlines a big drag. Industrial metals weighed on materials. Consumer discretionary was broadly down but buoyed by Amazon. Communication services was mostly lower, but Netflix was a big gainer. Consumer staples was cushioned by grocers, who benefited from consumer stock-up behaviour. Healthcare was a relative outperformer, helped by select biotech firms. Tech led the market, with software holding up best.
What mattered?
There were two distinct phases to Q1. The first was characterised by an equity market surging to all-time highs, despite concerns about a manufacturing slowdown, geopolitical tensions, and US political uncertainty. This phase quickly faded into the recesses of memory following the emergence of Covid-19 (coronavirus) as a global pandemic, largely shutting down the international economy while racking up a death toll that has already topped 40,000. The S&P dropped more than 35% from its 19 February record high through 23 March, before gaining some ground back on hopes of adequate monetary, fiscal, and public-health policy responses. As Q1 closes we see a US economy likely in recession, an epidemic that is still spreading, and day-to-day life largely on hold-and constant questions about how long the impacts may last, how deep the economic damage may be, and whether the extraordinary responses will, ultimately, be enough.
The Fed wastes little time dusting off the 2008 playbook
Early in the quarter, the Fed was keeping monetary policy on hold, though investors felt a future rate cut could help support the ongoing expansion. But the coronavirus threat upended this calculus, and on 3 March announced an emergency 50bp cut to the Fed funds rate. Then on Sunday 15 March, ahead of a scheduled 18 March meeting, the Fed cut rates to the 0.00 – 0.25bp range and announced a flurry of additional actions, including $700 billion in bond purchases and expanded repo operations. In the ensuing days, the Fed (with the approval of the Treasury Department) reopened or created several programs under its 13(3) emergency powers aimed at boosting liquidity in a range of markets. By 23 March, the Fed had announced the current QE round would be effectively unlimited, saying it would make purchases “in the amounts needed”. It is also prepared to lend to US businesses, with some $425 billion in Treasury funding ready to be levered up to ~$4T in loans. In taking these actions, Fed Chair Powell was seen as acting far more quickly and decisively than in the 2008 financial crisis, though it remains to be seen how effective these measures will be in limiting the economic damage.
Oil prices collapse after OPEC+ production pact breaks down
In addition to Covid-19, the global economy had to cope with a remarkable collapse in oil prices. West Texas Intermediate (WTI) crude had moved gradually lower through February as the coronavirus spread, raising worries about softer global demand. There was also some concern about whether the OPEC+ production-cut pact would be extended (or possibly deepened) beyond its 31 March expiration. While non-OPEC partner Russia had expressed some reservations about adjustments to the agreement, the pact collapsed entirely on 6 March amid a dispute between Russia and Saudi Arabia, with the latter responding by slashing April selling prices and signalling a big increase in output (supplemented by releases from storage). On Monday 9 March, crude dropped nearly 25%, its worst day since the US launched Operation Desert Storm in 1991. The move lower, and the further production increases announced by both the Saudis and Russia, had a profound impact on the outlook for US shale, especially for producers with high costs and/or debt levels. President Trump, for the most part, has focused on the consumer benefits of low oil prices, and his discussions with Russia’s Putin yielded little but promises for future consultations.
The key to outperforming global equity indices was NOT owning energy and financial stocks. That is where the real damage is. On the flipside, despite wide ownership, the best performing sector was again technology. This makes perfect sense to me as the vast bulk of fortress balance sheets in global equities lie in large cap technology stocks. Technology outperformance also makes sense because the sector will see the lowest level of revenue contraction over the next year. Interestingly, Microsoft (MSFT), my biggest investment, was flat for the quarter, despite their large weighting in US equity benchmarks. The world simply can’t open for business, either physically or remotely, without MSFT’s software and cloud computing products. Very few people would realise MSFT shares were flat for the quarter in an US equities rout.
While a summary of what has happened isn’t a guide to what happens next, I see it as a type of “damage assessment”. We need to know where the damage is structural and where the damage is cyclical. However, I would stress that just because a stock or sector is down -50% doesn’t mean it’s “cheap”. This remains a very fluid situation that may well get worse before it gets better.
The stunning first quarter also reminds you of the need for diversification in terms of asset allocation. If you only owned Australian equities in Australian dollars, you had a pretty rough time of it. If you owned leading high quality global equities in global dollars, the damage is very minimal to nil because the cushioning effect of the falling Australian dollar. My own fund returned -2.5% in the first quarter.
The next quarter will be volatile. Potentially highly volatile as the equity markets swing between hope (stimulus, low cash rates, flattening infection curves), and fear (mass unemployment, earnings and dividend downgrades). All I know is equity markets will bottom BEFORE inflection curves peak. For all our sake, let’s hope that’s sooner rather than later.
As we wait for that moment I encourage you, as always, to own the best portfolio you can. That will drive outperformance in just about every conceivable scenario.
Stay safe, and my best wishes to you and your families. That’s what matters most..
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.
