April 2020
US Economy: On-Demand Recession.
We are only just beginning to see the data evidence of a recession in the US. New unemployment claims the past two weeks have skyrocketed to a total of nearly 10 million as businesses have abruptly shuttered to combat COVID spread. To date, the most severe fallout has been borne by workers in retail and hospitality (restaurants, hotels, airlines).
US Stocks: Worst month since 2008.
The S&P 500 Index fell more than 12% in March in rollercoaster fashion. A key measure of stock market volatility — the CBOE’s VIX Index — finished above 60 on 10 consecutive trading days (triple its historical average of 20), as US equities entered a bear market (20% drop from the peak) and then rebounded at month-end after Congress passed a $2 trillion relief package.
Foreign Stocks: A difficult road for Europe.
Facing the global spread of the virus and headwinds from a stronger US dollar, non-US equities also tumbled in March offering little benefit for diversified portfolios. It seems this latest crisis will once again pit economically vulnerable countries, such as Italy and Spain, against Germany and the Netherlands, creating a major obstacle to effective European stimulus.
Fixed Income: Volatility not just for stocks.
Fixed-income markets were roiled by legitimate concerns over creditworthiness and an evaporation of liquidity with far more sellers than buyers. Even high-quality municipal bonds fell more than 10% at one point. The expansion of bond purchases and liquidity programs by the Fed, as well as fiscal stimulus by the US government, brought the markets back from the edge, munis included.
Real Assets: Oil price at 18-year low.
Oil prices fell more than 70% due to shrinking global demand and a big runup in supply as Russia refused to abide by OPEC production quotas. Daily demand for US gasoline and global jet fuel have fallen 40% and 60%, respectively, spurring US-Russia-Saudi Arabia negotiations to cut production.
Alternatives: Modest contributors.
Hedge funds weren’t immune to the COVID-19 sell-off but there were fairly large performance differences across strategies. Equity long-short funds generally fell more, whereas macro funds (managed futures strategies in particular) outperformed in March, catching shorter-term trends in asset prices.
Equities Total Return
| MAR | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | (12.4%) | (19.6%) | (7.0%) |
| U.S. Small Cap | (21.7%) | (30.6%) | (24.0%) |
| U.S. Growth | (10.4%) | (14.9%) | (0.4%) |
| U.S. Value | (17.6%) | (27.3%) | (18.0%) |
| Int’l Developed | (13.3%) | (22.8%) | (14.4%) |
| Emerging Markets | (15.4%) | (23.6%) | (17.7%) |
Fixed Income Total Return
| MAR | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (0.6%) | 3.1% | 8.9% |
| TIPS | (1.8%) | 1.7% | 6.8% |
| U.S. High Yield | (11.8%) | (13.1%) | (7.5%) |
| Int’l Developed | (2.2%) | (1.0%) | 2.3% |
| Emerging Markets | (4.4%) | (4.4%) | 0.2% |
| Tax-Exempt | |||
| Intermediate Munis | (2.5%) | (0.8%) | 2.4% |
| Munis Broad Mkt | (3.8%) | (0.7%) | 3.9% |
Non-Traditional Assets Total Return
| MAR | YTD | 1 YR | |
|---|---|---|---|
| Commodities | (12.8%) | (23.3%) | (22.3%) |
| REITs | (18.7%) | (23.4%) | (15.9%) |
| Infrastructure | (23.0%) | (29.2%) | (21.1%) |
| Hedge Funds | |||
| Absolute Return | (5.6%) | (5.8%) | (2.3%) |
| Overall HF Market | (5.9%) | (6.9%) | (1.4%) |
| Managed Futures | 0.3% | (0.4%) | 3.8% |
Economic Indicators
| MAR-20 | SEPT-19 | MAR-19 | |
|---|---|---|---|
| Equity Volatility | 53.5 | 16.2 | 13.7 |
| Implied Inflation | 0.9% | 1.5% | 1.9% |
| Gold Spot $/OZ | $1577 | $1472 | $1292 |
| Oil ($/BBL) | $23 | $61 | $68 |
| U.S. Dollar Index | 122.7 | 118.0 | 115.1 |
Our Take
It’s now consensus that the US will soon be in recession, if it isn’t in one already, as the economy is essentially shutdown with consumers sequestered in their homes. What makes the circumstances different historically are two factors: (1) how quickly the slowdown has materialized; and (2) self-imposed social distancing as the cause.
Looking forward, the big questions are: how long will the recession last; and how severe will the contraction be? Early indications are that the immediate consequences of the virus are likely to be severe, acknowledging the record unemployment claims at the end of March, which are anticipated to get worse from here. The duration of the recession is clearly tied to how fast the virus can be effectively contained, which relies on painful near-term economic sacrifices to protect public health. We have to see what kind of impact social distancing efforts have on the spread before being able to project with any confidence.
Next Several Months
At LNWM, we are focused on the simultaneous mandates of continuing to make necessary adjustments to reduce portfolio risks, which we think have dramatically increased from where they have been the last few years, and evaluating the best portfolio positioning to benefit from the environment that unfolds post-COVID. In other words, we are trying to figure out where the bottom is. The markets got a fiscal shot in the arm through the CARES Act, which will disperse $2 trillion (10% of US GDP) to impacted businesses and consumers. While the legislation buys time, it won’t drive an economic rebound alone.
We are looking at several areas for signals that we are nearing the bottom, including improvement in market liquidity, especially in the credit market, and a peak in virus cases, to name a few. How much further equities might fall from here (or rebound) likely relies on corporate earnings reports and on consumption and production activity. In LNWM portfolios, we have most recently recommended reducing international equities, which we think will continue to struggle in this environment and beyond. Europe clearly faces structural challenges, both economic and political, while the big drop in the price of oil adds an additional problem for many emerging market exporters.
