Island Light Quarterly Commentary (July 2020)
“To reach a port we must set sail – Sail, not tie at anchor. Sail, not drift.” Franklin Delano Roosevelt
In spite of it all, we must sail on. To get to our goals, we must sail on. To live in these uncertain times, we must sail on. Franklin Delano Roosevelt, one of our greatest and most controversial Presidents, who led the nation and world during the Depression and World War II, a victim of polio and a child of wealth, reminds us again of what we all instinctively know. Now is not the time to stop. Now is not the time to drift. Now is the time to move forward with sails set, the wind in our face and the wide ocean ahead. And so we do.
From two hundred and fifty miles overhead, the International Space Station views the earth as a beautiful orb, notable for its blue seas, white clouds, storm patterns, rich topography and bright electric lights at night. The men and women in the space station don’t see pandemics or racial disparity or anger or bankruptcy or any of the myriad terrible things going on in the human body, writ large. They also miss the beauty of the human spirit, our ability to love, help one another, act selflessly and be good. Without seeing humanity in all its richness, what do the orbiters miss? What do we on the ground miss, not being able to see from a great height?
Global equities sailed on in the second quarter, recovering most of the first quarter losses and ignoring the incessant rash of bad news about the global pandemic and US demonstrations. Staying invested paid off. The S&P 500 was up 20.5% for the quarter and down -3.0% for the year at June 30. Non-US equities in dollar terms continue to underperform the US, up 16.1% for the quarter and off -11.0% for the year (MSCI ACWI xUS). As we predicted at the beginning of last quarter, the volatility in the stock markets remains high. The CBOE’s S&P 500 Volatility Index (“VIX”) ended the quarter at 30, down from 54 on March 31 and up from 12 on December 31. Any value above 20 is considered to be higher than normal. The dispersion in US sector returns is quite significant; as one might expect, technology stocks and large growth equities led the recovery in the second quarter and year to date while energy and financial stocks were very weak.
US Bonds, as measured by the Bloomberg Barclays US Aggregate Bond Index were positive for the quarter, returning 2.9% for the quarter and 6.1% for the year to date. Risky credit-oriented bonds recovered much of their first quarter losses and longer duration treasuries were flat in the second quarter but up strongly for the year. Year to date, the best performance came from long dated US Treasuries, up 19.7% YTD (IA/SBBI Long Govt Index), the worst came from High Yield Bonds at (-14.9%) (ICE CCC rated). Credit markets have recovered nicely, buoyed by massive Fed action and continuing fiscal stimulus. Interest rates, as measured by the benchmark 10-year Treasury yield, ended the quarter at 0.66%, flat for the quarter (0.70%) but well off the beginning of the year value of 1.92%. These rates continue to be at their lowest range of the past 60 years.
The number of COVID 19 cases continues to rise globally even as the medical community learns to treat the illness. In the dark days of March and April, we really didn’t have a sense how bad it could be; now we have more information. Those at risk need to be really careful. Healthy people should use common sense (sorely lacking in a lot of us) to avoid the virus until a vaccine is generally available. We know that progress on the vaccine proceeds apace but until then, the virus will be with us.
So long as mandatory shutdowns are in place, the economy will remain weak with high unemployment and little growth. We expect that most restrictions on economic activity will be lifted this summer, and that a second viral wave will not force additional national shutdowns. Regional restrictions will come and go as viral pockets emerge. But ultimately, consumer behavior will drive economic activity, and we do not believe that the consumer will be freely spending on discretionary items (vacation lodging, air travel, dining out, sporting events) for a long time. We also expect demand will remain weak for commercial office space and energy-related goods and services as stay-at-home behaviors remain. The longer the virus continues, the more likely that these temporary changes in consumer behavior become permanent. While we invest in index funds, which include both winners and losers of consumer change, we also selectively invest in those growth areas, such as bio-technology or internet-based funds, that may benefit from these permanent trends.
Overseas, countries that have done a good job of controlling the spread of the coronavirus (Japan, Taiwan) have seen better economic output than countries that have done a poor job of controlling the virus (USA, Brazil, India). Some are predicting that Euro-area growth could fall as much as 20% this quarter and we expect Euro recovery to be weak. The drop in trade flows due to trade tensions and the pandemic contribute to this general weakness and internal consumer demand will need to drive the recoveries. Both emerging and developed markets look attractive relative to the US in terms of valuation, but overseas markets have disappointed for years. We retain our modest underweight to non-US equities and overweight to quality.
Other than for those with changed personal circumstances, we recommend keeping in place those investment decisions made before the pandemic. We are not making radical changes in investment holdings when the general uncertainty in the market place remains elevated due to the unknown duration of the health crisis, increased cultural tensions and an upcoming Presidential election, even as fiscal and monetary stimulus unbound by budget considerations continues. The outlook may be foggy, but we will stay on our long-term course.
Our disciplined approach to investment management using low cost index holdings, periodic rebalancing to long term targets and selective overweighting to long term growth assets and factors remains our strongest asset. We rebalanced many of our holdings in March when markets hit a short-term bottom and will continue to manage market volatility by staying in our target ranges as asset levels rise and fall.
Last week, we began the true summer season with the celebration of Independence Day and our country’s promise of freedom and justice for all. Let’s keep that universal truth of human rights in mind as we view our current situation. We choose to look from the height of the space station and with the words of FDR. Sail on. Take the world view. Stay the course. Look at the big picture. We make modest adjustments to the trim of the sails as the wind shifts but keep on our true course. Stay well, all.
Matthew V. Pierce