FIRST QUARTER 2020 COMMENTARY
DATE: April 1, 2020
FROM: David G. Dietze, JD, CFA, CFPTM, President and Chief Investment Strategist
I. Performance Update
• Stocks got blindsided in the first quarter, turning in their worst performance since the depths of the subprime crisis over a decade ago. The Dow’s return was the most negative since Q4 of 1987. Markets came into the quarter bolstered by an easing of tariffs and trade tensions with China, an accommodative Federal Reserve focused on keeping interest rates low, and a strong consumer economy with joblessness at a fifty-year low. However, the Coronavirus spread around the world, causing global commerce to freeze up. With significant amounts of the population sheltering at home, investors braced for recession or worse.
• The major market indices plunged over the quarter anywhere from 15% to near 40%, ending an eleven-year bull market. Over leveraged hedge funds, panicky individual investors, and large institutional investors rushed to the sidelines. Safe havens included sovereign debt, primarily US Treasuries; interest rates on shorter maturities fell below zero, while the yield on the ten-year Treasury had its biggest interest rate decrease since 2011. Gold got a bid, rising just over 4% in the quarter. A worldwide dash for cash, meaning the US Dollar, pushed up its value by nearly 3%.
• Only one Dow stock had positive performance in the quarter, Microsoft (MSFT), up by just a penny. Although no sector sported positive returns, technology, consumer staples, health care and utilities were relative outperformers, down “just” 15% to 18% for the quarter. Technology stocks’ relative attraction stemmed from their strong balance sheets; the enforced hibernation by many reinforced the attraction of smart phones, online ordering, and streaming entertainment. Now, however, valuations are stretched. Amazon (AMZN) and Netflix (NFLX) each trade at over 60 times earnings; what could go wrong? The other three sectors are considered less cyclical, and thus less vulnerable to the virus’ economic damage.
• Energy stocks led to the downside as the price of crude had its worst quarter ever. Fossil fuels slid on the supply shock of an apparent price war between major producers Russia and Saudi Arabia; investors later panicked, selling oil, as the implications of a virus-inspired demand shock became clear. Despite prices at the pump dropping below $1 in some parts of the country, demand cratered as drivers were sidelined by travel restrictions. Exxon (XOM) dropped 46%, Chevron (CVX) 40%. However, corporate insiders at energy concerns bet on a rebound as they bought up their shares at a record pace.
• Financials were the second worst performers; plunging interest rates squeezed their “net interest margins” (the difference between the interest received on their loans versus interest paid out for deposits). By the end of the quarter, lenders braced for possible defaults amid the fast weakening economy. Goldman Sachs (GS) and JP Morgan (JPM) each plunged 30%.
• Stocks put in what appeared to be an apparent bottom, perhaps quite temporary, on Monday, March 23, and headed higher for the next three days. Despite a weak Friday, it was still good enough to count as stocks’ best week since 1938. The turnaround was inspired by stimulus from both the Federal Reserve and Washington. The Fed lowered interest rates twice between meetings, never before seen, causing the Fed Funds rate to return to subprime crisis levels. Quantitative easing was cranked up, without apparent limitation, while bond purchases included municipals and corporates. Meanwhile, Congress launched a $2 trillion stimulus package roughly equal to 10% of our GDP.
II. Looking Forward
Long term we remain quite bullish. The Republic has never failed to surmount a health scare, nor proved unable to rebound from a correction, bear market, or worse. The question is the timing. Unfortunately, as Dr. Fauci of the CDC has pointed out, the virus sets the timeline, not investors or Washington. Near term, investors must brace for continued volatility with a retest or even plunge through the March 23 lows. The news flow will be demoralizing. On the health side, expect infections and fatalities to continue rising, while on the economic front brace for ugly news on layoffs, defaults, and business failures. Yet, hiding on the sidelines carries risks, too. Today’s ultra-low interest rates will fail to protect against the inflation that may well result from the current record stimulus.
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