Adrian A. Hedwig
Financial Advisor, CUSO Financial Services, L.P.
Available at all Salal Credit Union branches
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Quarterly Market Review, Jan-March 2020
The world’s economies and stock markets have been rocked by the spread of COVID-19. Investors’ fears prompted a major sell-off in February and March, plunging stocks well below their 2019 closing marks. Nevertheless, 2020 started off in a positive way. Following a strong 2019, stocks were slow to move forward as investors cashed in some of their 2019 gains. But by mid-January, each of the benchmark indexes were safely ahead of their 2019 closing marks. However, concerns over the COVID-19 outbreak in China quelled investor optimism. By the end of January, only the small caps of the Nasdaq remained ahead of their prior year’s pace, as each of the remaining indexes listed here fell into the red.
February started off as January ended, with investors more inclined to sell rather than buy equities. However, word of China’s plans to cut tariffs on some U.S. imports sent stocks higher during the second week of the month. The Nasdaq was more than 6% over its 2019 year-end value while both the S&P 500 and the Dow also pushed ahead. But by the third week of February, the impact of the virus was becoming evident with news of a widespread outbreak in South Korea. Selling accelerated the following week as outbreaks were reported in Iran and Italy. As more cases were reported in the United States, investors feared that containment of the virus was not likely and rushed to cash in stocks. By the end of February, each of the indexes lost significant value led by the Dow, which fell more than 10% for the month.
March 2020 will surely go down as one of the most turbulent months. COVID-19 continued to spread worldwide. In the United States, confirmed cases and, unfortunately, deaths spiraled. Fear became the motivating factor in our daily lives — fear of catching the virus, fear of the illness affecting our loved ones, fear of losing our jobs, fear of economic failure, and fear of losing our money. With respect to the stock market, this fear manifested itself in a major sell-off for most of the month. After falling sharply during the last week of February, stocks rebounded marginally to open the month. But that push was short-lived as stocks plummeted dramatically mid-March, despite the announcement of new actions and legislation by the Federal Reserve, Congress, and the President. On March 20, each of the benchmark indexes listed here posted double-digit losses. Year to date, the major indexes were more than 20% behind their 2019 closing values. The passage of the CARES Act at the end of the month helped ease investors’ concerns enough to move back to stocks. The end of the month saw each of the benchmark indexes post major gains, with the Dow marking its best single day since 1938. However, the spike in index values was not nearly enough to offset the major losses sustained throughout the month. March saw the Dow fall almost 14%, the S&P 500 drop over 12%, the Nasdaq lose 10%, the Global Dow give back close to 15%, and the small caps of the Russell 2000 plunge nearly 22%.
The first quarter of 2020 closed with each of the benchmark indexes securely in the red compared to their 2019 year-end values. The Russell 2000 again suffered the largest three-month fall, closing the quarter down nearly 31%. The Dow suffered its worst quarter since 1987, while the broader-based S&P 500 hasn’t seen a quarterly decline this bad since 2008. The Nasdaq fell more than 14%, marking its worst quarter since 2018. The Global Dow fell over 24% for the quarter.
By the close of trading on March 31, the price of crude oil (WTI) had sunk to $20.35 per barrel, well below the February 28 price of $45.19 per barrel. The national average retail regular gasoline price was $2.120 per gallon on March 23, down from the February 24 selling price of $2.466 and $0.503 less than a year ago. The price of gold finished March at $1,591.20, slightly higher than its February closing value of $1,585.80.
As of March 31
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
Latest Economic Reports
- Employment: Employment rose by 273,000 in February after adding 225,000 new jobs in January. In 2019, job growth averaged 178,000 per month. Notable job gains occurred in health care and social assistance, food services and drinking places, government, construction, professional and technical services, and financial activities. The unemployment rate dropped 0.01 percentage point to 3.5% for the month as the number of unemployed persons dropped by close to 100,000 to 5.8 million. In February, average hourly earnings for all employees rose by $0.09 to $28.52. Average hourly earnings increased by 3.0% over the last 12 months ended in February. The average workweek rose by 0.1 hour to 34.4 hours in February. The labor participation rate for February was 63.4%, the same as in the previous month. The employment-population ratio was 61.1% last month (61.2% in January).
- FOMC/interest rates: The Federal Open Market Committee held several emergency meetings in March, dropping the target range for the federal funds rate 150 basis points to 0.00%-0.25%. To further combat the economic impact of COVID-19, the Committee proffered a number of new and drastic measures. Among the actions taken by the Fed are unlimited bond buying including the purchase of corporate bonds; $300 billion in new financing; and the establishment of two new facilities, the Term Asset-Backed Securities Loan Facility to enable the issuance of asset-backed securities, and a Main Street Business Lending Program to support lending to eligible small and medium-sized businesses.
- GDP/budget: According to the third and final estimate for the fourth-quarter gross domestic product, the economy accelerated at an annualized rate of 2.1%, the same rate as in the third quarter. Consumer spending grew at a rate of 1.8% (3.2% in the third quarter), fixed investment fell 0.6% in the fourth quarter (-0.8% in the third quarter), and nonresidential fixed investment dropped 2.4% in the fourth quarter, compared to a 2.3% decline in the prior quarter. Consumer prices advanced at a rate of 1.4% in the fourth quarter, comparable to the third quarter (1.3%).
- Last February saw a budget deficit of $235 billion. Through the first five months of the 2020 fiscal year, the deficit sits at $624.5 billion, 14.8% greater than the deficit over the same period last fiscal year. Compared to the same period last year, government spending climbed 9.2%, far exceeding receipts, which rose 7.0%. In February, the largest expenditures were for Social Security ($91 billion), income security ($91 billion), national defense ($55 billion), and Medicare ($52 billion). On the income side of the ledger, social insurance and retirement accounted for $100 billion and individual income taxes totaled $70 billion.
- Inflation/consumer spending: According to the Personal Income and Outlays report for February, personal income rose 0.6% for the month, the same advance as in the previous month. Disposable, or after-tax, income increased 0.5% after increasing 0.6% in January. Consumer spending rose 0.2% in February for the second consecutive month. Price inflation remained low, however, as consumer prices inched ahead 0.1% for the third month in a row. Over the last 12 months, consumer prices are up 1.8%.
- The Consumer Price Index inched ahead 0.1% in February, the same increase as in January. Year to date, consumer prices are up 2.3%. Increases in prices for shelter (which makes up the largest portion of overall consumer costs) climbed 0.3% in February following the same 0.3% increase in January. Energy prices dropped 2.0% in February after falling 0.7% in January. Gas prices plummeted 3.4% while fuel oil prices decreased 8.5%.
- Prices producers receive for goods and services fell 0.6% after advancing 0.5% in January. The index has increased 1.3% since last February. Producer prices less foods, energy, and trade services inched down 0.1% in February following a 0.5% increase in January. Since February 2019, prices less foods, energy, and trade services moved up 1.4%. In February, producer prices for goods fell 0.9%, the largest decline since moving down 1.1% in September 2015. Over 60% of the February decrease in goods prices is tied to a 3.6% drop in energy prices.
- Housing: After falling 1.3% in January, existing home sales jumped 6.5% in February. Year over year, existing home sales are up 7.2% (9.6% for the 12 months ended in January). The median sales price for existing homes was $270,100 in February, compared to $266,300 in January. Existing home prices were up 8.0% from February 2019. Total housing inventory at the end of February was 1.47 million, an increase from the January rate of 1.42 million units for sale. Following a strong January, sales of new single-family homes decreased in February, falling 4.4% below January’s totals. Sales are 14.3% above the February 2019 estimate. The median sales price of new houses sold in February was $345,900 ($348,200 in January). The average sales price was $403,800 in February ($402,300 in January). Available inventory, at a 5.0-month supply, was slightly lower than January’s 5.1-month supply.
- Manufacturing: For the first time in three months, industrial production increased, climbing 0.6% in February after falling 0.5% the previous month. Manufacturing output edged up 0.1% last month but is still 0.4% below its level of a year earlier. Total industrial production was unchanged from a year earlier. New orders for durable goods climbed 1.2% in February following a 0.1% increase in January. New orders have advanced four out of the last five months. For the year, new orders for durable goods are up 0.4%. New orders for transportation equipment drove the increase, vaulting 4.6% in February. However, excluding transportation, new orders fell 0.6%. New orders for capital goods (manufactured assets used by businesses to produce consumer goods) jumped ahead 4.1% in February, driven primarily by a jump in new orders for defense capital goods, which soared 25.7%. Orders for nondefense capital goods inched up 0.5%.
- Imports and exports: Import prices fell 0.5% in February after inching up 0.1% in January. February’s drop in import prices was the largest decrease since a similar decrease last August. Since February 2019, import prices have fallen 1.2%. Fuel imports plunged 7.7% in February, the largest monthly decline since prices receded 7.8% in June 2019. Excluding fuel, import prices actually increased 0.3% in February. Prices for exports dropped 1.1% last month after advancing 0.6% in January. This is the largest monthly decrease in export prices since December 2015. Prices for exports decreased 1.3% on a 12-month basis from February 2019.
- The international trade in goods deficit was $59.9 billion in February, down from $65.5 billion in January. Exports of goods for February increased 0.5% to $136.5 billion. Imports of goods dropped 2.6% to $196.4 billion.
- The latest information on international trade in goods and services, out March 6, is for January and shows that the goods and services trade deficit shrank to $45.3 billion, $3.3 billion less than the December trade gap. January exports were $208.6 billion, $0.9 billion less than December exports. January imports were $253.9 billion, $4.2 billion lower than December imports.
- International markets: The spread of COVID-19 sent world markets and economies tumbling. With over 110 countries and territories reporting cases of the virus, major institutions and banks have cut their forecasts for the global economy. Several nations, led by China, have ordered certain areas locked down, restricting movements of millions of people and suspending business operations. China’s gross domestic product is expected to plunge to 4.9% this year, slower than earlier forecasts of 5.7% annual growth. Year to date, the STOXX Europe 600 Index fell almost 23%, Germany’s DAX slipped over 24%, France’s CAC 40 lost 24%, Italy’s FTSE MIB Index dropped 26%, the UK’s FSTE 100 Index has given back close to 23%, and Japan’s NIKKEI 225 is down 21%.
- Consumer confidence: Not surprisingly, the Conference Board Consumer Confidence Index® declined sharply in March. The index fell to 120.0 from February’s 132.6. The Present Situation Index — based on consumers’ assessment of current business and labor market conditions — decreased from 169.3 to 167.7. However, the Expectations Index, which is based on consumers’ short-term outlook for income, business, and labor market conditions, fell from 108.1 to 88.2.
Eye on the Month Ahead
Individuals’ health is of primary importance as the world continues to battle the effects of COVID-19. Of secondary, but great importance, is the impact of this pandemic on the world’s economies and markets. April will, hopefully, begin to point toward recovery of both personal and economic health. The impact of the CARES Act should begin to be felt by individuals and businesses next month. Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics
Key Dates/Data Releases
4/1: PMI Manufacturing Index, ISM Manufacturing Index
4/2: International trade in goods and services
4/3: Employment situation, ISM Non-Manufacturing Index
4/9: Producer Price Index
4/10: Consumer Price Index, Treasury budget
4/14: Import and export prices
4/15: Retail sales, industrial production
4/16: Housing starts
4/21: Existing home sales
4/23: New home sales
4/24: Durable goods orders
4/28: International trade in goods
4/29: GDP, FOMC statement
4/30: Personal income and outlays
Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. The U.S. Dollar Index is a geometrically weighted index of the value of the U.S. dollar relative to six foreign currencies. Market indices listed are unmanaged and are not available for direct investment.
Staying the Course Vs. Timing the Market
- As the old saying goes, time in the market is generally superior to timing the market. Yet, investors tend to have a bad habit of buying winners too late and dumping losers too soon.
- Staying the course does not necessarily mean sitting still. It means avoiding bad behavior, remembering your goal and ensuring your approach is applied with discipline.
“Stay the course” is a nautical phrase that has been popularized by world leaders, primarily in the context of battle. According to Stewart Alsop’s 1973 memoirs of a conversation with Winston Churchill, the British prime minister contemplated toward the end of World War II: “America, it is a great and strong country, like a workhorse pulling the rest of the world out of despond and despair. But will it stay the course?”1
We ask the same question today of investors, after what has been an emotive period for financial markets. From trade wars to Brexit, and now the dramatic implications of coronavirus, we’ve had plenty to deal with. So, what do we mean by “staying the course”? It is not always about sitting still (although this can be an appropriate path at times), but rather, to focus on the goal that you set in the first place and ensure your behaviors align with it.
Behavioral Errors Can Wreak Havoc on Long-Term Portfolio Returns
Let’s face it, investors too often redirect their attention from the destination to the journey. Much like in other walks of life, we can lose focus, making us susceptible to capitulation or giving up at the moments when fortitude and resolve pay off most. That is, people are hard-wired to be procyclical, chasing the winners and selling out of the losers because of a yearning to make money work harder for us. This is not just conceptual, it is practical (we can see evidence in the fund flow numbers).
Therefore, it is vital that as investors we remain vigilantly aware of how animal spirits can drive irrational decision-making, and that we adopt a well-reasoned and principled framework for investing. Principles matter; it is easy to have principles with a nice tailwind and smooth waters, but those placid conditions are not when principles are most valuable.
A Step-by-Step Guide to Staying the Course
The best thing an investor can do when contemplating change is to reflect on their goals.
Ask yourself this: “Given where I am now, what actions move me closer to my long-term goals?” “Would an investment change align with the original investment plan for reaching well-defined goals?” These are different questions than, “What do I wish I had done last month”? No doubt losses are painful. But reactivity to losses can induce a person to act rashly and make things worse in the long run.
So, the key question to ask is whether anything has fundamentally changed since setting the original strategy or whether it’s just that you are disappointed with your progress toward your goals.
If something has fundamentally changed, the question to ask is whether you can clearly identify what has changed. Write it down, then balance this by writing what it might mean if you’re wrong. This should include any misjudgment risk as well as the added costs if you decided to change investments (given where you are now). You may often find that the impulsive change you desire is not necessarily going to increase the probability of reaching your goals.
If it has “just” disappointed you, but nothing has fundamentally changed, the likely best option is to stay the course. By thinking probabilistically and remembering that investment markets never move in straight lines, you may avoid the perils of trying to time the market. Furthermore, you may benefit by doing the opposite to your intuition (given the evidence against it) and teach yourself to be a contrarian. Simply put, when bad things happen in the market, they have already happened to your portfolio, and that’s in the past. A contrarian views this volatility as an opportunity to find overlooked value in the market and invest in solid companies being sold cheaply by others who are in the grips of fear and undue pessimism.
How We Think About Staying the Course
As professional, multi-asset investors, we focus on investment objectives, always bearing in mind the opportunity costs and risks. We also write down a balanced thesis that ensures we control the emotions that can drive some decision-making. We have investing principles that don’t sway when the market lurches.
In this sense, staying the course is not idle or passive, but rather about staying aware and thinking in long timescales. Some investors may look at a recent period of lean returns and, with a hindsight bias and the herd mentality at play, will fear for the future. Many will further justify to themselves that reward for risk is simply not sufficient and will consider a change in strategy. This thinking is usually well-intentioned, but it may be dangerous and must be thought through with a long-term perspective.
Staying the Course vs. Timing the Market
Investing, like many things, often involves taking the thorns with the roses: There is no reward without risk. Over decades of evidence and through the investment literature there is one golden thread–the evidence clearly favors time in the market over timing the market. But “staying the course” to our way of thinking is subtly different to even “time in the market.” Time in the market sounds passive. Yet, if volatility were to spur a portfolio rebalancing, this keeps the goal in place and aligns with a long-term approach. This is what we would call staying the course. Perhaps returning this phrase to its nautical origin2 will help illuminate what we mean. Imagine you’re the captain of a ship, you’ve been given GPS coordinates as a destination, and are heading to reach that destination. If after a few hours you’re tired of holding the helm steady, this is akin to making portfolio changes for emotional reasons. If instead you find yourself blown off course, it would be foolish to not change your heading to align with the coordinates of your destination. We believe our valuation-driven investment approach does the latter. We seek the strongest winds and/or lightest chop, always keeping firmly focused on our destination, knowing the weather changes.
Align Every Change to Your Goal
It is important to reiterate that investors shouldn’t avoid change altogether, however must be far more calculating when they do make change. Valuation-driven investing is a good example of measured change in action, where Seth Klarman paints a thoughtful picture of the approach:
While some might mistakenly consider value investing a mechanical tool for identifying bargains, it is actually a comprehensive investment philosophy that emphasizes the need to perform in-depth fundamental analysis, pursue long-term investment results, limit risk, and resist crowd psychology.3
Bringing this together, we believe that “staying the course” is the right approach, patiently allocating to assets that will help you achieve your goal. So, if you catch yourself getting down about the state of the equity market or trying to predict what’s next, keep in mind these concepts and always remember why you are investing in the first place.
1 Alsop, S. 1973. Stay of Execution: A Sort of Memoir (Philadelphia: J.B. Lippincott Co.).
2 For what it’s worth, the original meaning of “stay the course” was probably different from our current meaning, which may be better said as “staying on course.”
3 Source: The preface of the sixth edition of Security Analysis by Benjamin Graham, 2008
COVID-19 Recovery: Does the Black Swan’s Flight Path Run Through China?
- The COVID-19 crisis has been a catastrophic “Black Swan” event that caused an exogenous shock to global markets.
- The financial pain and human suffering have been very real, but we encourage investors to remain calm and patient.
- We’re starting to see improvement in China and it’s not unreasonable to believe that western countries can follow a similar virus-containment path and start to recover economically. (Statements as of March 24, 2020.)
As of March 24, 2020, these are our thoughts. With that said, markets are moving quickly and our perspective may evolve with them.
We often talk about the potential of catastrophic “Black Swan” events that have the power to completely derail financial markets. Sometimes those events are largely contained within financial markets—as was the case in 2008. Other times they are exogenous shocks—as was the case with the 9/11 terrorist attacks. The current COVID-19 crisis certainly counts as an exogenous black swan.
Financial Pain is Real, but be Patient
The pain in financial markets is palpable. We have seen bigger one day declines—“Black Monday” in 1987—and we’ve seen numerous declines exceeding these total current losses. But we’ve never seen declines of this magnitude, over this short a time period. This, of course, engenders strong feelings in investors with many feeling the urge toward “loss aversion.”
While it may seem like a great idea to sell now and avoid further losses, this would create another problem of when to buy again to participate in the gains that have always historically followed these types of losses. If you invest with SEI you know that we always preach against the pitfalls of trying to time the market. In fact, with the losses we’ve suffered during the COVID-19 crisis, we’re probably closer to the bottom then the market top. And the closer we are to the bottom, the closer we are to the possibility of a sustained market rally. As SEI’s own Jim Solloway recently and colorfully put it, “I believe we’re more likely to see a face-ripping rally than another 30% decline.”
Now, it’s fair for investors to wonder how we can be optimistic about a rally when credit markets have all but seized up at the same time oil and equity markets tumbled amid massively volatile price swings. But we’ve seen thorough action on the monetary front from central banks that provides significant support across the range of credit markets, and we’re now starting to see a massive fiscal response in the form of government legislation. Perhaps, though, the most important change we are seeing is in the infection rates of the COVID-19 virus (see Exhibit 1) and what comes after those infections start to decline in countries like China.
The West Begins the Virus Fight
The Western world, including the U.S. and Europe, are surely in the early stages of combating COVID-19 and will see much higher numbers of infections, and unfortunately higher corresponding death tolls.
However, we can look to China for clues about what may come next. As the epicenter for the disease, China is much further along in this brutal fight. Early indicators have shown Chinese economic activity plunged into recessionary territory (see Exhibit 2) as the country was forced to take draconian actions to stem the infection rate.
Similar situations are beginning to take shape in the West, although quarantines and lockdowns are being imposed less stringently than in China. After taking dramatic action, China has seen its infection rate slow dramatically and economic activity has begun to come back as the situation improved. It seems likely that the West may follow a similar course if appropriate actions are taken, with Italy serving as a cautionary tale.
China is Recovering
While growth in much of the developed world is grinding to a halt, China seems to be revving back up. China has been the world’s growth engine for a while now, so it’s not unreasonable to think that a return to growth there can help stave off some of the impacts of tightening conditions elsewhere. It’s difficult to get timely and accurate data on the Chinese economy, but by all accounts the situation seem to be improving. On March 1, about five weeks after massive quarantine efforts started, China reported that over 90% of its state-owned firms were back to business. Smaller firms, albeit, appear to be operating at a lower capacity. On a more anecdotal level, we saw Apple reopen all 42 of its stores in mainland China on March 13, even as it maintained indefinite closures at all its stores outside of China.
SEI’s John Lau, Portfolio Manager for Asian and Emerging-Markets Equities, has a closer view from our Hong Kong office. He notes the situation is akin to a mosaic: you put little snippets of information together to create a full picture. While the situation is far from normal for both retail and manufacturing, the general consensus is that it’s getting better fairly quickly. If the rest of the world follows China’s path, the coming global recession could potentially be relatively short.
To reiterate, this has been painful. The human suffering, along with the destruction of value and demand, have all been very real. At least in terms of value destruction, however, we believe that we’re closer to a rally off the bottom than another 30% drop. As always, we encourage investors to review their goals and practice disciplined, globally diversified investing. These words are especially true in times of crisis.