March 31, 2020
‘Unprecedented’ seems like an understatement, but there are few other words that seem to properly describe the events of the first quarter. The year started off well enough, with the fourth quarter’s stock market momentum continuing through January and into February. In fact, U.S. markets initially ignored the spread of the COVID-19 virus in China, registering all-time highs in mid-February. When it became clear, however, that the virus would not be contained by national borders the market plummeted, registering the quickest 20% contraction on record and the worst individual day of losses (March 12th) since the 1987 crash. With the S&P 500 ultimately falling more than 30% from its all-time high on February 19th to its closing low on March 23rd, we have entered into the first “official” bear market since the financial crisis in 2008-2009. Even with a vigorous bounce off those March lows, the S&P remains in bear market territory. We would note that the rapid pace of the market decline led to highly correlated, indiscriminate selling across equity markets. During this tumultuous period, our Clients’ holdings of high quality, cash-rich secular and cyclical growth stocks held up much better than the S&P 500 and outperformed the Russell 1000 Growth from the February 19th peak to March 31st.
Seemingly as quickly as the virus overtook the United States, policy makers responded to buffer the economy. What took months to accomplish during the financial crisis in 2008 was enacted in a matter of days and weeks this time. The Federal Reserve said it would do whatever it takes to support the economy and financial markets and slashed the Fed Funds rate to 0%, announced unlimited quantitative easing and set up a number of facilities to support credit markets. Meanwhile Congress worked quickly to pass a $2 trillion stimulus package known as the CARES Act (Coronavirus Aid, Relief and Economic Security) to support workers and businesses.
The social distancing actions taken to help corral the spread of the virus will take a substantial toll on the U.S. and global economy in the short run. It is possible, if not probable, that economic indicators such as unemployment claims, the unemployment rate, retail sales, industrial production, etc., will hit readings that are more consistent with the Great Depression versus levels associated with any recession in our country since. We expect a sharp plunge in economic activity, with second quarter real GDP (Gross Domestic Product) likely to decline in excess of 25%, before we set a path to recovery beginning in the second half of the year. We currently see potential for a rebound to growth in 2021, fueled by pent up demand and extraordinary fiscal and monetary stimulus.
Global economies and markets have ultimately survived exogenous shocks like pandemics in the past and we believe this time will be no different. That in no way is meant to minimize the human impact an event like this will ultimately have. Importantly, the U.S. economy came into this exogenous shock on sound footing with few obvious imbalances. Employment gains had been strong, the consumer and services side of the economy was experiencing solid rates of growth, and we had begun to see improvement in some areas of the economy – most notably housing and manufacturing – which had been somewhat lackluster. Our banking system was also much stronger entering this recession as compared to the financial crisis. The shape of the ensuing recovery may be a “U” or it could be a “V”. If recent trends in China (such as traffic/congestion patterns, industrial production, coal consumption, property sales, etc.) are any indication, we should be on the path to recovery at some point by the summer months provided our efforts to slow the virus’s spread are successful in the coming weeks.
As for the stock market, volatility is likely to remain high in the near term. For a sustainable market bottom to form, we believe investors will need to see a slowing in the rate of new COVID-19 cases, if not an outright peaking of the disease. However, a bear market bottom is usually a process and this bear market isn’t even a month old with plenty of uncertainties and additional bad news likely still to come. So we expect more short term rallies and difficult setbacks in the days and weeks ahead. As the highly correlated, indiscriminate selling that marked the first phase of this bear market subsides, we believe that the higher quality stocks emphasized in our growth strategies will emerge as market leaders given their strong balance sheets and more resilient earnings growth.
Positioned with Strong Balance Sheets
