Another Wild Week
The longest bull market in history was brought to an abrupt end last week by the COVID-19 (coronavirus). While the US economy was in generally good shape from both a consumer (low unemployment) and business (wide profit margins) perspective, the slowdown in economic activity over the coming weeks will be dramatic. Positive test results have been reported in all 50 states, large gatherings have been cancelled, colleges and universities are sending students home and more than 32 million students are affected by K-12 school closings, with many opting for online learning. In a sign that might be most troubling for the digital generation: Apple has closed all stores outside of China, Taiwan and Hong Kong until March 27.
To add insult to injury for market participants, the breakdown of talks between OPEC and Russia led Saudi Arabia to announce a dramatic increase in oil production. This pushed prices down 30% early last week, and they are now down more than 50% since January 1. While this will benefit consumers in the intermediate term, it puts tremendous pressure on US oil producers. Over the past decade the US has more than doubled its output and became the largest global producer. Much of this production has been done through hydraulic fracturing (fracking), which is not economical with oil priced in the low to mid $20s.
During these times of market stress and anxiety producing headlines, it is important to remember that a key part of portfolio construction is diversification. This is the process of making investments across multiple markets (stocks, bonds, cash and others), which react differently to economic news. While most investors closely follow the S&P500, which is an index of large US stocks and is down more than 25% YTD, the bond market as measured by the Bloomberg Barclays US Aggregate Index is up slightly in 2020 as investors moved to the safety and security of fixed income. In addition, clients who have exposure to alternatives such as niche growth strategies have seen a degree of downside protection in recent weeks.
Another facet of prudent portfolio management is a rebalancing program. This is the process of shifting capital between stock, bonds and other asset classes so the portfolio does not stray too far from its target allocation. While a dogmatic approach is not necessary, and we must be mindful of trading costs and taxes, it is important to be clear-eyed about the long-term plan.
Lastly, market downturns can activate a “fight or flight” response and cloud an investor’s memories of calmer days. This is why having an Investment Policy Statement, which was deliberately and thoughtfully prepared, is so important. This document should continue to serve as the North Star for a portfolio. The chart below reflects how higher returns are ultimately the result from investors’ emotional overreaction to periods of market stress.
Beyond what we can control as investors, we look next to policy makers. The Federal Reserve has been active in recent weeks through its 50 bps rate cut on March 3, and an additional cut on Sunday March 15, which brought rates back to zero. Furthermore, it has announced a large program to ensure liquidity in the overnight lending markets for banks, and plans to purchase up to $700 billion of Treasury and mortgage-backed securities in the coming months. While many of the steps taken to limit the spread of COVID-19 had come from state and local officials, last week the President declared a state of emergency which has activated FEMA. Additional support to consumers and small businesses are also being considered by Congress. As further testing capabilities come online, we expect the number of cases to rise significantly. This, in conjunction with information on the scope of the economic impact, will prompt some very severe headlines. Although the financial markets look forward, we do anticipate meaningful volatility in the weeks to come.
Since our founding in 1981, Oxford has been singularly focused on helping our clients achieve their long-term goals. Our decades of professional experience tell us that investors are rewarded for being patient and disciplined through periods of turmoil and uncertainty. The depth and experience of our team allows us to build and manage diversified portfolios that have stood the test of time (and previous bear markets). While we will remain at an appropriate social distance based on the CDC’s recommendations, our team is fully available to discuss your portfolio or other questions on your mind.
The above commentary represents the opinions of the author as of 3.17.20 and are subject to change at any time due to market or economic conditions or other factors.The information above is for educational and illustrative purposes only and does not constitute investment, tax or legal advice.