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2020 1st Quarter Review

Date Posted: April 16, 2020

We hope you are well during this period of great uncertainty and stress. In such a short period over the past year, investors confronted extreme market conditions that typically evolve over decades. We’ve read the phrase “There are decades where nothing happens; and there are weeks where decades happen.” (V. Lenin). That quote captures the magnitude of events that the Coronavirus crisis triggered during the last few weeks of 2020’s first quarter.

Over the next weeks, months, and years the consequences of these events will propagate like waves affecting many facets of economic, social, and political life. These waves will likely generate increased market volatility that make timing the markets a foolish endeavor. Consider the following market gyrations since the middle of February:

• S&P 500 reaches all time high level on February 19,

• from February 19 to March 23, the S&P 500 saw the quickest meltdown in history, for a loss of 33.9%,

• then it gained 17.5% over next 3 days for the best 3-day stretch since the 1930s.

Clearly, we strongly recommend against trying to time the markets. One should not confuse luck for skill, particularly in this environment.

Former Federal Reserve Board (FED) Chairman, Ben Bernanke, was asked about how the current crisis compares to the Great Depression during a CNBC interview in late March. He said, “This is a very different animal than the Great Depression ….. while this has some of the same feel of panic, it’s really much closer to a major snowstorm or natural disaster.” Global central banks and policy makers implemented extraordinary actions to mitigate the disruption caused by this Coronavirus natural disaster. In a matter of days, they’ve done more than what took months or longer during the 2008 crisis. We support these historical and unprecedented policies (ultimately measured in the $10s of trillions).

Our FED deserves tremendous credit for their fast action and the overwhelming breadth and depth of tools deployed to prevent a serious downward spiral. Importantly, the consequences of these policy actions will impact financial markets and economies long after a vaccine for COVID19. Today, the vast range of potential outcomes demands greater integration of research across macro, micro, and risk management disciplines to manage effectively and achieve our longer-term objectives. Below we discuss key points to focus on as we navigate through these uncharted waters.

REDUCING CONSUMER AND INVESTOR CAUTION — FIRST STEPS

Virus Mediation Our recent commentaries have focused on consumers’ “psyche” as one key to the ultimate speed of an economic recovery. Improved consumers’ “psyche” will likely require more than mediation policies to reduce their virus-induced caution. The same concerns affect investors’ “psyche.”

Virus Therapeutics – Initially, moderating the virus impact will hopefully come from therapeutics currently in development and tests. Therapeutics would reduce lengthy treatments for COVID-19, substantially reducing capacity pressure on hospitals. Such therapeutics include antibody cocktails, convalescent plasma, and anti-virals (see Figure 1). Effectiveness depends on their use in the early stages of infection. Therefore, timely testing will prove the key to their success. These therapies could partially reduce consumers’ caution by knowing a virus treatment exists.

Figure 1
Drugs in the Pipeline
Start Dates for Experimental COVID-19 Drugs
Source: The Wall Street Journal

Therapeutics Important to Initial Economic Steps Forward – Potential success for these treatments would likely push recovery forward from the current economic valley. That valley will likely last through at least the third quarter of this year—if not beyond. Because of their importance, financial markets will immediately react to development reports for these therapeutics.

Opening the Economy More Difficult Than Shutting It Down – The recovery timeline will require careful planning to determine the steps needed to open the economy. With no vaccine at present, opening the economy will require rigorous testing and tracing strategies to avoid serious recurrence of the virus. So far, publicly, neither the White House nor Congressional leaders seem focused on developing this strategy. Without a historical basis for judgment, investor caution seems the best approach during the gap period between opening the economy and, hopefully, successful completion of vaccine trials.

VACCINE SUCCESS KEY TO 2021 GROWTH

Accelerating Vaccine Production – The key to next year’s growth will be a successful vaccine that prevents COVID-19 from reoccurring. To reach that goal early in 2021, the Federal government and other non-profit sources will underwrite the risks of starting to build production facilities before final vaccine trials prove their efficacy.

Investors Will Respond Quickly to Vaccine Headlines – A vaccine broadly available in the first part of 2021 will produce higher overall consumer and business confidence leading to more rapid economic growth in the second half of the year. Once again, investors will quickly respond to headlines reporting the vaccines’ critical development results.

Fed and Congress Massive Stabilizing—Spending “Real Money” – In the meantime, while the country now waits for therapeutics and vaccines, both the Federal Reserve and Congress have made massive commitments to the economy. Most observers look at these commitments as stabilizing efforts, not a stimulus. In its phase 3 package, Congress added over $2 trillion of fiscal spending. At the same time, the Fed will boost its balance sheet from about $4 billion to initially $8 billion and probably higher in supplying liquidity to the credit markets. In effect, the Fed nationalized our credit markets. To paraphrase a senator of yore, a trillion here, a trillion there, and pretty soon you’re talking about real money.

Ballooning Fed Balance Sheet—Little Immediate Inflation Concerns – Early in the last decade, when the Fed’s balance sheet first ballooned, many economists expected higher inflation rates would eventually show up. The reverse proved to be the case. With the doubling of already ballooned debt levels in the Fed’s balance sheet, most observers seem quiescent about potentially higher rates of inflation. At the same time, the rapid increase in debt levels over the last decade reduced the marginal impact on GDP growth from each dollar of increased debt. That trend will likely continue and reduce the benefits of such incremental debt longer-term.

More Fiscal Spending Packages Likely – Economists estimate that closing the economy for some period will cost roughly $3 trillion. The gap between that estimate and the $2 trillion phase 3 fiscal package will likely lead to a phase 4 fiscal spending package totaling over one trillion dollars. This additional spending will likely consist of many similar provisions in phase 3 — unemployment supplement, small business loans, and hospital funding. As presidential politics moves closer, proposed new controversial spending programs will likely result, and delay passage. Depending on the bumps in the road, once the economy opens, additional fiscal packages seem likely. This spending eventually leads to higher taxes marking the end of the lowered tax rate era. Milton Friedman once said, “nothing is so permanent as a temporary government program.”

Changes—Business, Financial, Social, and Political – As America gradually opens up, significant changes will make prior economic, business, social, and political assumptions less valid. Our commentary outlines a few obvious changes for business, finance, politics, and our society that the virus may bring. Readers will be adding many more changes to our very limited list.

TRADE WAR AND COVID-19 –EXPOSES THIN SUPPLY LINES

Reducing Single Source Dependency and Thin Supply Lines – The combination of the trade war and COVID-19 will lead some American firms to reconsider single-sourced finished products and components from Asia. Further encouraging that change, growing 24-hour delivery times could also lead to shifting supply chains to North America. This shift would reduce both growing inventory requirements and associated working capital to finance that growth. This pandemic also demonstrated the thinness and inflexibility of current supply lines that depend on roughly thirty-day ocean shipping times from Asia.

Globalization Weakened—Will Inflation Follow? – For these reasons, more global supply chains will likely move to North America — including Mexico. This shift will not occur overnight but gradually, when businesses invest in new products and manufacturing facilities. Importantly, economists cite the contribution of globalization to lower inflation — might that change as the trend to North America develops. Bringing production back to North America could result in greater use of robotics to moderate higher labor cost pressures. Moving supply chains to North America would work to the benefit of ground transportation — both truck and rail. If this shift occurs, overtime, US ports, and container shipping would likely see slower growth.

BIOSECURITY CHANGES THE WORLD — HIGHER NATIONAL BORDERS

Heavy Dependency on Imports of Drugs and Ingredients – Dependency on medical imports during the pandemic crisis raised a red flag. This red flag brings biosecurity to the forefront for sourcing of medical and pharmaceutical manufacturing and supplies. According to an article in Politico, 80% of the US supply of antibiotics come from China. That represents just one example. India, another drug source for this country, imports a substantial amount of its active pharmaceutical ingredients from China. So does the United States.

Increasing Investment in Biosciences — Medical Equipment – With biosecurity a critical national security issue, the US will likely create incentives for moving pharmaceutical manufacturing back to North America. At the same time, investment in biosciences — both corporate and venture capital — will likely escalate. Similar issues apply to medical equipment supply chains for hospitals.

Bioscience Stocks Benefit — Reduced Political Pressures — National Interests First – With this biosecurity emphasis, selected stocks in biosciences should benefit. This should prove to be the case with the two most prominent critics of the drug industry out of the Democratic presidential primary race. Both trade and biosecurity changes suggest a further pullback from global to national interests.

STOCK BUYBACKS—DECREASED ACTIVITY

Will the SEC Change Its “Safe Harbor” Regulation, or Will Congress Act? – Before 1982, stock buybacks rarely existed under SEC regulations due to the threat of a manipulation charge. In that year, the SEC issued a “safe harbor” rule that protects companies from liability for stock manipulation when buying their own stock. In the current political environment, generally hostile to stock buybacks, some may call on the SEC to reverse its “safe harbor” ruling. If not, Congress may take action to do so.

Reduced Stock Buybacks — Lower EPS Growth — Higher Stock Volatility – Banning stock buybacks would reduce earnings per share growth (EPS). Over the last fifteen years, Goldman Sachs estimates that earnings per share for corporations grew roughly 2.5% faster than their reported net income from the benefits of stock buybacks. In addition, higher stock volatility could result without the support of stock repurchases. Even if stock buybacks can continue, it seems unlikely in the current political environment that companies will borrow to buy their stock. At the same time, those companies with substantial liquidity will likely return to purchasing their stock once this difficult period passes.

PANDEMIC COULD SHIFT POLITICAL TRENDS EVEN FURTHER

Two Generations Coming into Adulthood in Deep Recessions – Two generations will feel the effects of deep recessions. The first generation came into adulthood during the great financial crisis (GFC). The slow recovery delayed normal life events such as jobs, marriage, children, and owning their shelter. As a result, many members of that generation saw Senator Sanders as answering their frustrations.

Political Effect – Now we see a second generation moving forward into adulthood through a life-affecting experience and economic downturn. Depending on the nature of the changes that the pandemic brings and the speed of economic recovery, they will likely face the same life delaying events as the previous generation. If they follow that generation’s political tendencies, merging these two generations will bring significant political change to this country.

MARKET RECAP

Coronavirus Shocks World Markets – The global community faces an unprecedented challenge in combating the spread of the 2019 Novel Coronavirus (COVID-19). As a result, in the first quarter world markets experienced a steep selloff, broken up by small rallies. Facing the prospect of a recession in the U.S. and around the world, risk-off sentiment took hold of investor behavior. To combat the sudden economic slowdown that is necessary to fight the Coronavirus, the Federal Reserve and Government will flow at least $6 trillion into the economy to stabilize it and stimulate recovery. With consumer spending responsible for close to 70% of gross-domestic-product (G.D.P.), the speed of any potential economic recovery will importantly depend on how long the virus affects consumer sentiment and willingness to spend.

Markets Digest Unprecedented Monetary & Fiscal Support – To support Americans and the economy, congress passed the largest stimulus package in American History. The stimulus includes support for individuals, small businesses, and corporations harmed by the Coronavirus-related slowdown. The Federal Open Markets Committee (FOMC) cut its short-term rate to near-zero, and the Fed has indicated a continued effort to purchase bonds (referred to as quantitative easing) and ensure market liquidity.

EQUITY

Domestic Equity

U.S. large-cap equity returned negative -19.6% for the quarter, as measured by the S&P 500 TR index, while U.S. small- to mid-cap equity returned -29.7%, as measured by the Russell 2500 TR index. After reaching new highs in February, investors quickly faced the effects of the Coronavirus, dramatically repricing risk across equity styles. As a result, the bull market that ran for more than a decade following the Great Recession abruptly ended. Defensive sectors, including utilities, real estate, and consumer staples fell least. Energy, however, came under intense pressure as geopolitical factors resulted in sharply lower oil prices, returning negative -51.6% as measured by the S&P 1500 Energy Index, making it by far the hardest his sector during the quarter.

International Equity

International developed markets large-cap equity returned negative -22.8% for the quarter, as measured by the MSCI EAFE NR USD index. As Western Europe combats severe outbreaks of the Coronavirus, especially in England and Italy, markets there will continue to experience increased volatility. Emerging markets, which had not experienced the recent stock price rises in the U.S. and other developed countries, returned negative -23.6% for the quarter, as measured by the MSCI Emerging Markets N.R. index.

FIXED INCOME

Historic events occurred in fixed income, as yields on all U.S. Treasurys fell below 1.0% at the same time. Core fixed income returned 3.1% for the quarter, as measured by the Bloomberg Barclays U.S. Aggregate Bond TR index. On the maturity side, bonds with 1 to 3-year maturities returned a positive 1.8% as measured by the Bloomberg Barclays U.S. Aggregate 1-3 Year T.R. index. Bonds with 5 to 7-year maturities returned a 2.7% as measured by the Bloomberg Barclays U.S. Aggregate 5-7 Year T.R. index. Bonds with maturities of 10 years or more returned 6.21%, as measured by the Bloomberg Barclays U.S. Aggregate 10+ Year T.R. index. During the quarter, government bonds returned 8.1%, as measured by the Bloomberg Barclays U.S. Government index. Corporate investment-grade bonds returned negative -3.63% as measured by the Bloomberg Barclays U.S. Corporate Investment Grade index. High Yield Bonds returned negative -12.68% as measured by the Bloomberg Barclays High Yield Corporate Bond index.

ALTERNATIVES

Alternatives outperformed equities, as expected during an equity downturn, although returns were still negative for the quarter. As measured by the U.S. Fund Multialternative peer group, alternatives returned negative -9.7%.

INVESTMENT CONCLUSIONS

COVID-19 shocked the world. Investors, along with their fellow citizens, lacked any basis to determine the outcome from this pandemic. This virus will likely come under control in the not too distant future. With that, the economy will rebound, admittedly at some uncertain speed, but recover it will.

In this time of challenge and uncertainty, we continue to focus on quality companies marked by higher rates of returns on equity, low financial leverage, and steady earnings growth. Reaching that recommended equity asset mix leads to rebuilding equity positions in high-quality companies with strong balance sheets selling at what will likely prove attractive prices. For fixed income, look to shorter-duration fixed income securities to preserve capital, especially given the recent moves seen in fixed income markets.

Points to consider when reviewing markets and allocating asset classes:

KEY MACRO POINTS:

  • Mitigation of Coronavirus spread is essential for economic recovery
  • Comprehensive diagnostic testing, improved therapies, and ultimately a vaccine will lead to increased confidence
  • Consumer sentiment moving forward key to U.S. economic outlook
  • Inflation may accelerate given market forces (longer term)
  • Over the next three years, the economy will likely recover its sustainable growth rate of about 2+%

 KEY ASSET ALLOCATION POINTS:

  • Higher quality U.S. equities with growth prospects available at what will prove to be attractive prices
  • Preference for U.S. equities over international positioning to weather the current environment
  • Core fixed income remains unattractive
  • Liquid and private alternatives remain attractive in the current low interest rate environment

 

As always, please feel free to contact us if you have any questions.

 

SkyView Investment Advisors

 

Disclosures

SkyView Investment Advisors, LLC (the “Firm”) is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. The Firm’s form Adv part 2a & 2b can be obtained by written request directly to: SkyView Investment Advisors, LLC, 595 Shrewsbury Ave, Ste. 203, Shrewsbury NJ 07702. This is prepared for informational purposes only. It does not address specific investment objectives nor is the content intended as an offer or solicitation for the purchase or sale of any security. Although taken from reliable sources, the Firm cannot guarantee the accuracy of the information received from third parties.

 

An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results.

The S&P 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value, The index is widely regarded as the best single gauge of large-cap U.S. equities.

The Russell 1000 Value Index measures the performance of those companies in the Russell 1000 Index with lower price-to-book ratios and lower forecasted growth values. The Index is calculated on a total return basis with dividends reinvested and is not assessed a management fee. It is not possible to invest directly in an index.

The Russell 2000 index is an index measuring the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.

The Russell 2500 Index is a broad index, featuring 2,500 stocks that cover the small- and mid-cap market capitalizations. The Russell 2500 is a market cap-weighted index that includes the smallest 2,500 companies covered in the Russell 3000 universe of United States-based listed equities.

The MSCI World Index captures large and mid-cap representation across 23 Developed Markets (DM) countries. With 1,633 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI EAFE Index is an equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the US and Canada. With 920 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

The MSCI Emerging Markets Index captures large and mid-cap representation across 24 Emerging Markets (EM) countries. With 1,125 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country.

ICE BofAML US High Yield Index value, which tracks the performance of US dollar denominated below investment grade rated corporate debt publically issued in the US domestic market.

The BBgBarc US Agg Bond TR index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States.

Using only liquid securities, the Credit Suisse Liquid Alternative Beta Index seeks to replicate the return of the overall hedge fund industry, as represented by the Credit Suisse Hedge Fund Index.

The Credit Suisse Liquid Alternative Beta Index reflects the combined returns of the individual LAB strategy indices – Long/Short, Event Driven, Global Strategies, Merger Arbitrage and Managed Futures – weighted according to their respective strategy weights in the Credit Suisse Hedge Fund Index.

An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance to certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Past performance is not a guarantee of future results.

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