Q1 2020 -- Searching for Clarity
COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q1 2020 - Searching for Clarity
Financial markets have quickly reflected the new reality that a global coordinated response will be required to thwart COVID-19's spread. This unfortunately will come at the expense of a sharp global economic slowdown. As troubling as the rapid descent of stocks into bear market territory has been, we all need to think first about our health and the health of our loved ones. The velocity at which this virus is spreading has led governments to outright shutdown in order to flatten the COVID-19 curve. As investors are ridden with fear and apprehension due to constant doses of unsettling headlines, a little perspective can go a long way. Policymakers around the globe are taking swift decisive actions to mitigate the virus itself and its economic effects with unprecedent monetary and fiscal stimulus measures. It took just six weeks for Congress to pass a $2 trillion fiscal package. In comparison, it took several months and several bank failures in 2008 before Congress finally put together the $787 billion legislation called the American Recovery and Reinvestment Act. The Federal Reserve and U.S. Treasury brushed up on the 2008 playbook and were not afraid to use it.
The S&P 500 returned -20% for the quarter which marked the worst first quarter recorded for the index. On a relative basis, the technology heavy NASDAQ performed better by returning -14.20%. The investor fear gauge, as measured by the VIX index, experienced the highest percentage increase in its existence. Given the velocity and magnitude of the virus fallout, unemployment claims have well surpassed historic levels and will continue to do so in the near term. Key economists are forecasting the unemployment rate to overshadow the post-World War II record high of 10.8%. We will soon have a better understanding on the state of corporate America as earnings reports will start to provide clues on the health of the economy. Analysts are currently forecasting first quarter earnings to decline year-over-year by -5.2%. This will surely be subject to revision as a great number of companies have elected to not provide forward guidance.
The $2 trillion fiscal package includes direct income support to Americans, business support of $500 billion, increased unemployment insurance benefits, immediate funds for hospitals, and gives $367 billion of loans and grants to small businesses. The package represents more than 9% of gross domestic product and is larger than the three major packages enacted during the 2008/2009 recession.
The Federal Reserve unleashed a massive monetary policy stimulus package consisting of unlimited quantitative easing and slashed its interest rate target to between 0% and 0.25%. Investors were relieved when Chairman Powell stated that he does not see negative interest rates as a potential policy measure. The Federal Reserve will continue to buy assets and provide support in amounts needed to maintain a smooth functioning market. The Federal Reserve not only acted with unprecedented urgency, but with aggressive measures in order to mitigate the virus's economic effects.
The reaction in credit markets has been just as volatile with credit spreads widening at a faster pace than any other time in history. During selloffs of this nature, the market does not always make distinctions in terms of quality. Liquidity in the credit markets has been quite challenging as investors sold anything liquid to raise cash. U.S. Treasury yields across the curve moved materially lower which was reflective of the flight to quality. The 10-year treasury ended the quarter at 0.67%, declining 125 basis points, or 1.25% lower, since 12/31/2019. The High Yield bond sector retreated like other riskier parts of the market due to concerns of rising defaults and the health of the energy sector. Foreign bonds were down -0.33% for the quarter, while the Barclays Aggregate Bond Index was higher by +3.15% for the quarter. The best performing sector in fixed income was long-term treasuries with maturities of 20 years or longer.
THOUGHTS ON ASSET ALLOCATION
Global markets have swiftly moved down to price in a grim outlook as COVID-19 outbreaks and containment measures remain at large. We will one day see the virus panic subside and markets settle into a bottom, but we are not at the liberty of picking a week or month of when that will happen. If we can highlight one positive this quarter, it would be the size and scale of government intervention. We cannot underestimate the extraordinary fiscal and monetary policy measures put forth that will eventually aid a recovery in the future. Our Investment Committee has been actively monitoring these evolving market conditions and speaking daily with our best-in-breed managers. With equities 25% or more off their February highs, it isn't time to say equities are "cheap" yet. Corporate earnings remain the big unknown making it impossible to identify what cheap means. Growth continues to outperform value this year even during the market drawdown. Our Committee will be actively discussing our growth and value balance within our models in order to strike the appropriate mix for the rest of 2020 and beyond.
While history never exactly repeats itself, it usually rhymes with the past. Our industry leading managers have been resilient during past market declines. Even with the indiscriminate selling and extreme volatility experienced in the first quarter, several of our managers performed better than their benchmark. Listed below is a subset of our equity managers for the first quarter with many outperforming their respective mandates.
Investment Manager / *Q1 2020 Return / Manager Benchmark
Federated Strategic Value Dividend / -23.29% / -29.35% Dow Jones US Select Dividend
Merger Fund / -2.39% / -7.16% HFRX ED: Merger Arbitrage
Harding Loevner International / -19.37% / -23.26% MSCI ACWI ex US TR
Baron Small Cap / -23.34% / -25.82% Russell 2000 Growth TR
Polen Capital Large Cap Growth / -12.64% / -14.10% Russell 1000 Growth TR
*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios.
For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Michael Unger, Investment Officer, at 786-292-0310.