Market Overview

The first quarter of 2020 was a difficult one in the markets, with the overwhelming majority of asset classes ending in negative territory. Following a year in which major equity markets delivered double-digit returns and high-quality bonds posted their best returns in 10 years, the markets were severely impacted by the onset of the coronavirus. As we stand here today, there have been almost 2 million cases globally, with 610,000 in the U.S.

As seen in the table below, the equity markets endured a broad-based decline, and the pace of the selloff has been among the quickest in history. For example, the U.S. stock market, as represented by the S&P 500, fell into a 20% bear market in the shortest time ever – just 22 days¹ – and continued further, dropping 30% in a record 30 days. The typical historical bear market peak-to-trough decline has taken around 12 to 18 months. Volatility has been extremely high. Since the beginning of March 2020, the S&P 500 Index has moved up or down by more than 4% on 13 of 22 trading days, which is unprecedented.

U.S. large-cap stocks were the best performers once again, with a -19.6% return, although this was the biggest quarterly decline since 2008. Small-cap stocks were the worst performers, declining 30% for the quarter. International developed and emerging markets stocks underperformed U.S. large-cap stocks, but in local currencies there was not much of a difference, as most of the relative return arose because of currency weakness vs. the dollar. Energy markets were especially hard hit, and oil prices had their biggest one-day drop since the 1991 Gulf War, plunging 25% on March 9, triggered by a price war between Saudi Arabia and Russia.

Fixed income was also challenged in the first quarter of 2020 and provides an interesting historical case study. While the equity markets peaked on February 19, credit markets didn’t begin to sell off until March 4. In addition, from February 19 to March 9, the U.S. Treasury market responded as expected, with yields declining sharply in response to a global flight to safety. On March 9, as the COVID-19 crisis intensified, a massive rush for liquidity began to overwhelm this traditional flight to safety. For a time, even the Treasury market was not immune to these pressures. From March 9 through March 18, for example, the Barclays 10+ Year Treasury Index declined almost 16%, and 10-year Treasury yields actually rose from 0.54% to 1.19%. During this period, cash was the only fixed income sector that had positive performance. For the entire month of March, the Barclays U.S. Aggregate Bond Index, with a 43% weight to Treasuries, posted a return of -0.6%.

The credit markets have begun to recover but, despite massive intervention by the Fed, are not back to levels seen before the COVID-19 crisis. For example, a U.S. Corporate 1-5 Year BBB-Rated Index still trades at a spread over 30 basis points wider than the longer-duration U.S. Corporate 5-10 Year Index.² In more normal market environments, shorter-duration credit spreads are narrower, which indicates that pricing pressures are continuing to negatively affect the short portion of the yield curve.

With this as the backdrop, the Federal Reserve increasingly stepped into markets over the course of March to help address these imbalances. After aggressively cutting interest rates in early and mid-March, the Fed began addressing liquidity concerns in fixed income markets on March 17. Its policies have addressed dislocations (supply and demand imbalances) in money market and commercial paper markets, overnight funding markets, primary and secondary corporate issuance and asset-backed security markets, to name a few. Throughout the past few weeks, the Federal Reserve has acted with unprecedented size and speed and has indicated that it is committed to continuing to use its balance sheet to restore liquidity to fixed income markets. On a positive note, fixed income markets remain open, and there has been a wave of investment grade corporate issuance allowing high-quality companies to shore up their balance sheets even further.

Manager Overview

Our Investment Research Group (IRG) has and continues to be in close contact with each of our managers to better understand the impacts of COVID-19 on their portfolio companies. Our team pays particularly close attention to how our managers are navigating portfolio decisions while adhering to their stated investment processes. Just as we expect our managers to be re-underwriting and stress-testing their investments, IRG is re-underwriting our managers and ensuring that they are tackling this environment with appropriate discipline and skepticism.

The first order of business for all of our managers has been to confirm that their portfolio companies have staying power even in the most draconian scenarios. Next, they have been assessing the magnitude of the dislocation between price and value across their opportunity set. Our managers have been upgrading to higher-quality investments that are now more reasonably priced in order to capture great long-term value while also improving the quality of their portfolios.

Many of our managers entered this period of increased volatility with significant cash allocations, which helped them protect capital on the downside. Several portfolios had been building cash toward the end of 2019, as managers saw valuations creep near and beyond their estimates of fair value, leading them to opportunistically sell or trim exposures. As the selloff began and subsequently deepened, our managers started to deploy those cash balances at what they believed to be very attractive entry points, buying the stocks of high-quality businesses whose prices had become dislocated from their underlying values.

As we navigate this very difficult time, there are a handful of powerful investment tenets both IRG and our managers rely on to navigate the current environment:

• Know what you own, and why you own it.
• Identify business-level staying power.
• Recognize that volatility represents an opportunity to upgrade the quality and prospective return of a portfolio.
• Appreciate that “timing the bottom” is a fool’s errand, and a systematically measured approach to increasing equity allocations is prudent.
• Understand that having a long-term investment horizon presents the ultimate arbitrage opportunity as capital shifts from panicked to patient hands amidst the near- to medium-term uncertainty.

Past performance does not guarantee future results.