Island Light Quarterly Commentary (Apr 2020)
“To every time there is a season under heaven.” Ecclesiastes
In preparing for this quarter’s investment note, I reviewed my year end commentary and 2020 outlook. Last quarter’s quote from Ecclesiastes is even more pertinent today than it was last quarter. This is the season when “global pandemic” has been sadly re-introduced into our lexicon; the other great scourges — bubonic plague, smallpox, cholera, typhoid, meningitis, Spanish flu – are the stuff of history but now wrought real. Yet by all accounts, Covid 19 is milder, and its case mortality lower, than the afore-mentioned pandemics. But it is our pandemic, the pandemic of the modern world whose spread across the globe is measured in days and whose impact on the global economy was and is profound in its speed and impact. And it is still going on, and we do not know how and when it will end. Those other great horrors of illness are history that we read about, not something that we live. This scourge, we are living, and its end is uncertain. 2020 will go down in history as the year of the novel coronavirus. This is our season under heaven.
I don’t want to write about investment performance this quarter. I want to write about investment behavior. Let it be said that the S&P 500 was down (-19.6%) for the quarter and year-to-date. Non-US equities in dollar terms performed worse, off (-24.1%). To give some perspective to the speed of the losses, on February 19th, the S&P 500 was up 4.5% YTD at an all time high of 3,394. One month later, on March 23, the index closed at 2,237 a drop of 34% in 23 business days. Volatility, as measured by CBOE’s S&P 500 Volatility Index (“VIX”) rose from 14 on that day to 72 and higher — levels not seen since the worst days of the 2008 market crash. Frankly, equity behavior is so volatile that the quarter end that we’re measuring here is already forgotten five business days from the quarter end as I write this.
US Bonds, as measured by the Bloomberg Barclays US Aggregate Bond Index were positive for the quarter, returning 3.2%. The type of bond held mattered a lot this quarter. The best performance came from long dated US Treasuries, up 19.6% YTD (IA/SBBI Long Govt Index), the worst came from High Yield Bonds at (-22.5%) (ICE CCC rated). Credit markets dried up as sellers liquidated positions, margin calls came due and cash (and US Treasuries) became preferred assets. Without unprecedented Fed action and massive fiscal stimulus, the results would probably have been much worse. Interest rates, as measured by the benchmark 10-year Treasury yield, ended the quarter at 0.70%, up from the quarter low of 0.54% on March 9 and from 1.92% at the end of last year. These are the lowest 10-year interest rates for US Treasuries ever. Ever is a long long time.
After “Are you feeling ok?” the next important question is “how long is this going to last?”. This is the key question. The longer the duration of the health crisis, and the longer that a mandatory shutdown is in place, the longer the downturn of the economy. An educated guess is that this virus will be with us for a long time. Past viruses came in waves. The first wave hits an area, people get sick and then heal, the virus returns on an airplane from somewhere else and the people who didn’t get sick the first time get sick and make — the second wave. And so on. The pattern stops when so many people have caught the virus that there are more immune people than the virus can make sick again. A vaccine, which is likely more than a year away from broad circulation, will help create a benign immunity. Until then, we will probably continue to practice self-isolation.
What will this mean? Look around you. Right now, we are in the initial stages of self-isolation. Your favorite restaurant is closed. The hotel at the airport is closed. Your doctor’s office is closed unless you get really sick. No professional sports. No conferences. No church, gym class or movies today. The lawyers, accountants, politicians are working from home. The plumbers, steel workers and salon owners don’t have that luxury. No amount of government stimulus ($2 Trillion and counting) can bring all of that lost income back. Five weeks after the first CV19 death was reported, ten million Americans, 6% of the workforce, filed unemployment claims. Goldman Sachs forecasts a 34% drop in GDP this quarter. Some expect forty million workers, a quarter of the American workforce, to file for unemployment in the next month. This dislocation will have a material lasting impact on the US economy,
While social distancing measures appear to be slowing the spread of the virus in the US and in developed markets, we should expect further global disruption, particularly in developing economies where the urban poor live, crowded together in unsanitary living conditions with already strained or non-existent health services. The negative impact on developed economies has been extreme; one can only imagine the tragedy to come in emerging economies.
In the US, we will probably be in better shape than those with less robust health systems. In a year or a year and a half, we will all be getting vaccines and having tests. We’ll have certificates of immunity, like passports, like they are now offering in Germany. Let’s go with consensus and say that fiscal and monetary stimulus will substantially temper the downturn and we will have a soft landing, followed by a robust recovery in 2021. Then we can worry about the return of inflation and the impact of enormous budget deficits and the like. Stuff for another day.
But what about the time between now and March of 2021 when we can all get the vaccine or have developed our own immunities? We have to anticipate more volatility. For one thing, in November we will have a presidential election. For another, we will have that second wave of hot spots. Many of the jobs lost today will never come back; while some new ones will develop, they won’t be sufficient to make up the gap the longer this health crisis lasts. Also, the longer the stay at home order goes on, the more our social behavior will change. Now don’t get me wrong, we are social beings and need to be in community together. I just have a hard time imagining 100,000 Big 10 football fans packed into the stands at the Ohio State / Michigan football game in November, particularly if we have no vaccine on hand. Or airplanes being full of happy tourists coming from or going to China or Tuscany in July. That is just not happening in 2020.
I said that I wanted to discuss investment behavior, not investment performance. As one of my clients asked the other day; is your advice still to keep calm and carry on? The short answer is yes. We are still in the middle of a health crisis whose outcome is far from known. We cannot predict with any certainty in which direction the economy will go until we have better resolution on the duration and scale of the health crisis. If your employment situation has changed, then you should review your budget and investment plan while tapping into your precautionary cash reserve. For the rest of us, staying on the course established in the calm days before the crisis remains the reasonable choice.
Staying the course does not necessarily mean staying in place and not making changes to the investment portfolio. Maintaining your target equity/bond allocation means buying equities when equity balances drop out of range. This will take advantage of the benefits of dollar cost averaging. In taxable accounts, exchanging assets with losses for similar assets can realize taxable benefits. Some trading is advantageous when markets are down and volatile so long as the overall allocations remain consistent with one’s long term strategy. For example, we rebalanced our tax-advantaged accounts back to our target allocations towards the end of last quarter.
One more comment; some of the long-term trends that we have long anticipated such as working from home, buying local, job dislocation due to advances in technology, online shopping, last mile delivery and the like; those long term trends got kick-started at the end of February. There will be winners and losers in this new economy and new social behaviors are now changing in real time. Companies will adapt or die to this strange new world. The lucky companies who happen to be in the right space will win. Crafting a long-term investment strategy that matches that long-term change outlook is not a bad approach to take at this time. A lot has changed in a very short time span and we would be prudent to review our portfolio positioning, if not our long-term asset allocation.
This week is Holy Week. We celebrate Passover and Easter with our families, friends and faith communities virtually, in a strange new transition. We hope that you stay healthy and active in this season under heaven.
Matthew V. Pierce