It is remarkable the change that one quarter can bring. This time three months ago, the new coronavirus had not yet been identified in China, and now we’ve had over 826,000 confirmed cases of COVID-19 at the time of this writing, resulting in over 40,000 deaths and changing the fabric of our life as we know it.
Financial markets have not been immune to the coronavirus fallout, as panic-driven selling along with the uncertainty of our new economic reality combined to send asset prices sharply lower during the first quarter. The S&P 500, one of the best barometers for US stock performance, fell -20% in Q1, marking the worst quarterly performance for US equities since 2008. Overseas equities fared similarly, declining -24% as measured by the MSCI ACWI ex-US Index. In addition to coronavirus fears, markets were also rocked by a collapse in the oil market, as price wars between Saudi Arabia and Russia contributed to a -67% decline in oil prices during the quarter. Within fixed income, government bonds rallied as the Fed slashed interest rates back to zero as part of a broad monetary stimulus package, with the Bloomberg Barclays US Government Bond index gaining +8% in Q1. Corporate bonds, on the other hand, fell as markets sought to price increased defaults risks, with investment grade corporates falling -4% and more speculative high-yield credits falling -12%. Gold continued to prove a useful hedge, with spot prices rallying +6% on the quarter. A balanced portfolio, comprised of 60% in global equities and 40% in fixed income, would have fallen -12% in Q1.
While fear may have driven the bulk of the selling so far this year, our data-driven Three Dials investment philosophy has allowed us to maintain a steady approach to the ever-changing investment landscape. With the situation rapidly developing from both an economic and an epidemiological standpoint, below is a snapshot of where each of our primary indicators stand as of the end of the quarter:
The CBOE Volatility Index, commonly known as the VIX and used as a gauge of investor fear, has remained elevated for much of the month, indicating a high degree of uncertainty around the future direction of equities. Meanwhile, the depth and swiftness of this selloff has caused short-term moving averages to fall below their long-term counterparts, marking a bearish technical indicator. While it is possible that we have seen the bottom of this current bear market, continued choppiness and a retest of the lows is likely. Thus, our Momentum and Sentiment Dial has switched to a “Negative” reading for the time being.
What we know so far is that we’ll see a strong Q1 GDP number in the US (currently estimated at +2.7% by the Atlanta Fed GDPNow model), followed by a sharp contraction in Q2, which has already been priced into equity markets. It remains to be seen how the global economy will respond in the back half of the year. The aggressive fiscal and monetary response from global governments and central banks indicates an accelerated recovery, but all of this depends on how the virus is contained in the coming weeks and months. One bright spot comes from China, where manufacturing activity is rebounding quickly. Through the end of March, we’ve not yet seen enough data to move our Economic Dial from its “Positive” position. This is likely to change as more data is released over the coming weeks and months.
Coming into 2020, equity markets were “priced for perfection” after a big rally in 2019. As earnings expectations have come down, so too have valuations. However, we’ve not yet seen US stocks move from expensive to cheap just yet, as multiples remain above long-term averages. As such, our Valuation Dial remains in a “Negative” position.
On balance, our Three Dials composite reading takes a somewhat defensive view into the second quarter. While it is possible that we have seen the worst of this bear market, history indicates that we may be in for a retest of the March lows in the coming months.
Sources:
https://coronavirus.jhu.edu/map.html
https://www.nytimes.com/article/coronavirus-timeline.html
https://www.cnbc.com/2020/03/31/stock-market-today-live.html
https://www.frbatlanta.org/cqer/research/gdpnow
https://www.sciencemag.org/news/2020/03/can-china-return-normalcy-while-keeping-coronavirus-check
https://www.multpl.com/shiller-pe