Q1 2020 Insights

 

How did the markets do?


  • All major equity indices across geographies, market caps, and sectors exhibited significant declines in the first quarter.  The rapid spread of the COVID-19 virus and the ensuing lockdowns triggered the swiftest plunge into a bear market[1] in history as investors tried to price an imminent global recession of uncertain depth and duration.
  • Investors and leveraged strategies purged positions, while some funds were forced to sell their most liquid investments just to meet redemptions.  Meanwhile, there were no large institutional buyers on the other side, waiting to buy up the shares and bonds being dumped.
  • As market liquidity evaporated, bid-ask spreads[2] for equities widened, while high-yield debt and even investment-grade bonds experienced substantial yield expansion.
  • Unlike previous crises, global central banks moved quickly to stabilize the financial system. An unprecedented amount of liquidity support has already been committed, and governments around the world are spending trillions of dollars in an attempt to support their economies through several expected months of suspended animation.
  • By the end of March, the immense liquidity injected into the global financial system had helped to stabilize the market freefall, and since quarter-end we have seen some recovery from the depths witnessed in late-March.

What about the economy?


  • The global economy has been paralyzed by the lockdowns, and unemployment is spiking. Despite extraordinary support from central banks and fiscal lifelines, it still faces a broad set of intense headwinds from financial market dislocations, business disruptions, dividend cuts, debt downgrades, defaults, and other fallout from the lockdowns.
  • However, while this may end up being a deep global recession, it also has the potential to be one of the shortest, assuming social distancing orders are taken seriously and virus testing becomes more widely available.
  • Longer-term, we may see a reduction in globalization as companies decide that their supply chains have become too complex and too reliant on “just-in-time” production halfway across the planet.  Central banks may also face less independence than they have enjoyed (to varying degrees) in the past, forced to keep short-term interest rates low (even in the face of inflation) and continue to serve as compulsory buyers of debt.[3]  Furthermore, consumer preferences may be permanently altered as a result of the extended lockdowns.

What are we doing?


  • While we have never experienced a pandemic of this nature before, we have gone through severe market downturns and recessions before.  These episodes of high volatility and market stress are never easy to stomach, for the seasoned and novice investor alike.  However, these are the critical moments when short-sighted, emotional decisions can have long-lasting ramifications for your wealth.
  • We are adhering to our discipline, staying the course, not selling out of long-term investments, and making small tactical adjustments within portfolios.  We are taking advantage of the temporary decline by executing tax-efficient security exchanges, as well as upgrading certain holdings into higher-quality names that have sold off hard.
  • Our active equity and fixed income managers have also been very busy in the midst of the market turmoil, topping up existing holdings and buying new positions whose prices had fallen to attractive entry points.
  • It remains unclear whether the lows seen in March are as far as markets will decline this cycle or if we are due for a secondary correction.  As we redeploy capital back into the market, we are proceeding gradually and are focusing on higher quality assets and sectors that we believe are oversold.

What risks are out there?


  • The longer the suspension of economic activity continues, the higher the strain it will put on corporate and personal balance sheets, jeopardizing the survival of some entities and also making an eventual restart more difficult.  That said, prematurely relaxing lockdown measures risks triggering secondary waves of infections before a vaccine is ready or anti-viral treatments are sufficiently researched and distributed, leading to further lockdowns later in the year.
  • Continued fiscal and monetary support will be critical in the short term, but that comes with a long-term price tag for future generations.

 

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[1] A bear market constitutes a fall of over 20% from a prior peak.
[2] A bid-ask spread is the difference between the highest price a buyer is willing to pay for a security and the lowest price a seller is willing to sell.

[3] Fels, Joachim.  Economic Outlook: From Hurting to Healing.  Pacific Investment Management Company LLC, April 8, 20


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