Markets Update: A Quarter in Review
Divergence in global policy around the handling of the Coronavirus has become the central theme around investing, economics, and geopolitics in 2020. While we don’t know what grade the U.S. will receive in its response, we certainly know it will not be top of the class on the health policy side as medical experts are unfortunately sidelined to politics. However, massive and early fiscal and monetary responses have staved off the worst effects on the economy for now. With all the uncertainty in the direction of the economy and capital markets, discipline around maintaining global diversification and rebalancing remains very important in your portfolios.
BONDS
Investment grade fixed income had another good quarter on the back of a good 1st quarter, with U.S. bonds returning 2.90% and global bonds earning 1.76%. After a rocky first quarter, the municipal bond market settled into its position as a tax-advantaged diversifier to volatility of stocks. We continue to favor owning bonds with high credit quality ratings and avoid low quality bonds that tend to underperform exactly when you do not want that to happen. We also are holding a meaningful tranche of fixed income portfolios in highly liquid, shorter duration bonds, as a way of providing stability in the portfolio and as a source of liquidity for unexpected expenses.
STOCKS
After a difficult beginning of the year, equity markets staged a spectacular climb in the second quarter. While valuations are stretched, they are not at the exuberant levels seen during the dot-com bubble of the late 90’s. Experts put this rise in equity markets in two corners: 1) investors are looking past 2020 to future company earnings, 2) the rapid acceleration of a new economy where companies that benefit from ‘working from home’ and online retail are rising in value. We expect the stock markets to be whipsawed by the ever-evolving news around the coronavirus. All stock indices were meaningfully positive for the quarter with U.S. stocks up 22%, international stocks up 15%, and emerging markets stocks up 18%. All together we see volatility continuing throughout 2020. That said we remind ourselves to expect the unexpected and not to rely on short term forecasts to drive your investment strategy.
ECONOMY
Last quarter, we noted that the global economy will almost certainly be classified as in recession for the 2nd quarter of 2020. We know that is now a certainty. This quarter we share the opposite, noting that the 3rd quarter will almost certainly be classified as the beginning of the economic recovery. This is the theme of the economy and the stock market right now – record speeds in dropping and recovering. Does this scenario require a new term to be coined for what we are experiencing? A “pandession” perhaps? Economic data have, so far, staged a very swift recovery, with the June Jobs report showing a record 4.8 million monthly gain following a 2.7 million rise in May. However, this still represents just 1/3rd of the 22 million jobs lost in the prior two months. Moreover, the real limits to economic activity in a pandemic, combined with a rising number of new infections, and an end to key parts of the CARES Act all threaten to divert the recovery from the highway to the back roads. A new stimulus package would help to avoid taking the offramp, with Congress expected to deliver in early August. We are watching vigilantly. Once the pandemic is brought under control, we expect demand to come back meaningfully. This suggests two things: 1) Resilience from a diversified portfolio across stocks, bonds, and geographies is even more important today. 2) Focusing on your long-term investment plan and rebalancing your portfolio will likely be rewarded over the next few years.
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Topic of the Quarter: Long-Term Investors, Don’t Let a Recession Faze You
With activity in many industries sharply curtailed in an effort to reduce the chances of spreading the coronavirus, investors may be tempted to abandon equities and go to cash because of perceptions of recessions and their impact. But across the two years that follow a recession’s onset, equities have a history of positive performance.
Data covering the past century’s 15 US recessions show that investors tended to be rewarded for sticking with stocks. Exhibit 1 shows that in 11 of the 15 instances, or 73% of the time, returns on stocks were positive two years after a recession began. The annualized market return for the two years following a recession’s start averaged 7.8%.
Recessions understandably trigger worries over how markets might perform. But history can be a comfort for investors wondering whether now may be the time to move out of stocks.
GLOSSARY
Fama/French Total US Market Research Index: The value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available outstanding shares and valid prices for that month and the month before.
Exclusions: American Depositary Receipts.
Sources: CRSP for value-weighted US market return.
Rebalancing: Monthly.
Dividends: Reinvested in the paying company until the portfolio is rebalanced.
