Year in Review – Twelve Months ended March 31st, 2020
Given the monumental impact of the coronavirus disease (COVID-19), it is virtually impossible to discuss the twelve-month period as a continuous period. It’s more sensible to think about the world before COVID-19 (to be referred herein as BCV) and after (ACV). For our purposes here, we will define that demarcation point as the middle of February, when investors woke up to the cataclysmic impact the disease would have on the economy. There is little one could say about BCV that would be applicable to ACV.
BCV the focus was on issues such as: impeachment, Brexit, presidential primaries, and trade wars and truces. In the world of ACV, the issues are starker: 1) individual health and 2) national and global economic survival.
The BCV economy was positive for the American economy and consumer, although growth slowed noticeably as the year wore on. Purchasing power gathered strength due to low inflation, and wages rose a bit faster than in previous years as unemployment fell to levels considered impossible just a few years ago. Federal Reserve rate cuts buoyed investor confidence.
ACV the economy is at a standstill. Official statistics are lagging indicators, but we know that perhaps 20 million Americans lost their jobs before the end of March. Many others face an uncertain future. It is certain that the global economy entered a deep recession and the timing and strength of the recovery remain unknown.
Major Economic Events
No nation was able to escape the impact of the COVID-19 disease. Hardest hit have been the US, Italy, Spain and China. Commodity producers have also suffered as demand vanished overnight.
The Federal Reserve, the US government, and governments worldwide have scrambled to deploy every tool at their disposal to keep economies afloat until the disease becomes better understood, better managed, and perhaps preventable via development of a vaccine. Levels of borrowing have already reached levels not seen since World War II and seem likely to rise from here. At this point (end of March), it’s much too early to assess the impact and effectiveness of the governmental responses.
As if things weren’t bad enough for the energy sector due to the collapse in demand, Saudi Arabia, Russia, and the US decided this would be a good time to fight for market share. Prices plummeted, and although this can be good news for consumers and resource-poor nations, it was devastating to oil-dependent economies such as parts of the US and energy producers globally.
The Equity Markets
Global stocks plunged in the first quarter of 2020, erasing all gains from 2019. An index of global stocks fell by -22%. This drop occurred within a span of just four weeks and includes the sharp upward move during the last week of March. For the year global stocks fell -12%.
Stock markets were particularly susceptible going into 2020. Profits had stagnated throughout 2019 and the stock market gains of 2019 could be categorized as a triumph of hope over reality. ACV, profits have diminished drastically. At this point, there is no clarity as to what investors can or should expect in terms of corporate profits or dividends.
The American stock market performed better than its international counterparts. Part of this reflects a flight to the perceived safety and quality of the US dollar, which rose against counterparts. International markets fell by -16%, while the US markets fell by high single digits.
Although long-term investors in small and mid-cap stocks have been rewarded for the elevated risk of these firms, there is no doubt this has been an extremely difficult period. In 2019, rising labor costs and a slowing economy hampered smaller firms. The COVID-19 induced economic collapse impacts smaller firms more severely as they have less ability to weather a deep downturn. It is still unclear if governmental policies and interventions will suffice, or if they will largely be directed to the larger and better- connected firms. A good case can be made that given the magnitude of the declines that small cap investors have already endured (-32% in Q1-2020), investors can be reasonably optimistic about this asset class going forward.
China’s markets were significantly impacted by the ebb and flow of the trade war. The news of a truce spurred a rally towards the end of 2019. Interestingly the Chinese market has fared relatively well in 2020 vs. the US and other major economies.
Natural resource stocks tracked the price of oil and collapsed in 2020 when demand vanished, and suppliers flooded the market. REITs were very hard hit in 2020 as the future value of much commercial real estate has come into question.
Overall, the effects of diversification from the traditional S&P 500 index were extremely negative. Every major asset class fell significantly short of the S&P 500.
The Fixed Income Markets
It was a strong year for US bonds, particularly government offerings. Prices rallied as the Fed cut rates during 2019 and then slashed rates to zero percent in response to the crisis. The broadest index of US investment-grade bonds rose by 9%. Corporate bonds fell in 2020 but ended the twelve-month period with gains. Municipal bonds experienced similar price movements. The collapse of tax revenues plus the strains of coping with the health crisis are placing major strains on state and local budgets. The federal government has declared its intent to support the finances of states and local governments, although as with much, the breadth and effectiveness of these interventions is unclear.
International bonds were basically flat, as price gains were offset by the impact of the rising dollar. Cash and similar investments had benefited from the Federal Reserve’s increases in rates, and will now continue to drop in alignment with Fed policy.