For the first six weeks of the first quarter of 2020, stock markets managed to continue the upward climb that had started twelve months earlier. However, as all readers of this Market Recap know, the world changed in mid-February. The Coronavirus, more recently renamed Covid-19, initially disrupted Chinese supply pipeline to U.S. companies. At the time, the economic impact from the virus appeared manageable. Ultimately, the major financial disruption from Covid-19 was the worldwide shutdown designed to slow the spread among humans. No surprise, the stock market reacted quickly and negatively to the closure of global business activity. In less than five weeks, major stock indices had declined by 30% to 45%. Investor’s reaction was the indiscriminately selling of all stocks regardless of the effect the pandemic might have on any particular company. The selling then extended to bonds and money markets as credit spreads expanded. As dire as the environment seemed, these sellers quickly regretted their actions. With the announcement that the U.S. government had approved stimulus programs in excess of $2 trillion, the higher quality stocks changed directions. In the final seven days of March, stock markets regained 12% to 18% of the losses. Although this tremendous last week helped, it did not erase one of the worst stock market quarters in American history.
For the three months ending on March 31, 2020 the NASDAQ had lost the least with a decline of 13.91%. Value and small cap stocks suffered the most. The Russell 2000 Small Cap Index ended the first quarter with a 30.62% pullback. The Dow Jones Industrial Average and the MSCI EAFE International index both fell by 23%. The S&P 500 lost an even 20%.
The “second shoe to drop” in the first quarter was the result of public transportation being viewed as high risk for transmitting Covid-19. This was further supported by the virus outbreaks that were occurring on cruise ships. As a result, the demand for oil and fuel plummeted as riders and tourists avoided crowded spaces. Meanwhile “stay-at-home” orders began to emerge in cities and states around the country and personal car use went down sharply. This led to a price war in crude oil between Saudi Arabia and Russia as each rushed to build cash reserves. Oil inventories surged and prices collapsed. This oil glut led to additional pressure on energy companies and high yield bonds.
Even with these negative quarterly returns, the prospects for long-term investment strategies have not changed. D’Arcy Capital strategies are modeled with quarterly results similar to what we just experienced. Although it can be tough to observe in the short-term, it will not change the long-term performance goals for managed accounts.
In previous Market Recaps, D’Arcy Capital has frequently discussed the benefits to our clients of separating investment risks and opportunities from everything else going on in the world. We are very sensitive to the world around us today, however, it is our mission to strip the emotional pressures from portfolio management and focus on the responsibility of growing assets. It is our fiduciary duty to shoulder the responsibility for our client’s portfolios. As many people, eager for signs of an end to the pandemic, watch daily press conferences, real-time websites, and multiple social media sites, D’Arcy Capital is making decisions on what is likely to transpire in one year, three years, and ten years. It is important to realize the time for investing in preparation for a pandemic has past, but the investing for a recovery from a pandemic is still in front of us.
The longer term outlook for stocks not only looks very positive, but the ownership of stocks is going to be very critical. The stimulus funding is likely to reach $3 trillion in the United States. Most people are still struggling to quantify $3 trillion (there are only 4 countries in the world that have GDPs of $3 trillion or more). By comparison, the Troubled Asset Relief Program (TARP) was $750 billion in 2008. This fueled the growth of the economy for the next 10 years. The current relief programs are 4 times larger than TARP. The post pandemic environment (unclear when this will be but probably not in 2020) will include the $3 trillion stimulus, 0% interest rates, low energy prices, massive pent-up demand, and a lack of goods to meet the dollars chasing them (shipping and manufacturing have been disrupted). All of this is inflationary. Stocks have a unique ability to adjust for inflation. While some investors are searching for stocks that will benefit from the “new normal” like video conferencing, remote work stations, and social distancing mechanisms, more successful investors will be buying stocks of companies that have been in business for decades. These firms have seen similar events before and have survived and thrived. These same businesses are now selling for a massive discount.
As much as things changed, they also stayed the same. FAANGM (Facebook, Amazon, Apple, Google, and Microsoft) stocks were the best group of stocks before the pandemic selloff and they are arguably the best performing group of stocks since the pandemic began. They are also the most expensive and remain the most risky. These five stocks now account for 20% of the S&P 500.
D’Arcy Capital is using this opportunity to continue to invest in undervalued stocks, sectors, and asset classes. The small cap sector offers the best risk/return proposition of all the asset classes. Value stocks will have the largest rebound post pandemic. Additionally, investors who wish to benefit most from the recovery should adopt the mantra “fix liabilities and float assets.” Use the low interest rate environment to lock-in loan obligations and invest cash in appreciable assets such as stocks and businesses. Volatility will continue but incredible opportunity remains.