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Quarterly Commentary – March 2020

As we close out this quarter and look to the next, we are in a unique situation nationally and globally. Our hearts go out to everyone as we adjust to this unprecedented event. To our clients and friends on the front lines in our community and around the world, “Thank you” seems so inadequate, but we want to extend to you our deepest appreciation and admiration.

Early in the year, U.S. equities continued their upward move up until February 19 when the U.S. equity market proceeded to drop in an unprecedented manner. From the peak to the bottom, the S&P 500 dropped around 34% in 33 days, the steepest drop in such a short a period since 1931, which was during the Great Depression. Then the S&P 500 made a major rebound from March 23 but did not fully retrace the losses. The following are performance numbers from various popular indexes. Please remember index numbers are not individually comparable to a properly diversified portfolio. Each portfolio may include an allocation to securities similar-to these indexes in varying amounts based on your personal risk tolerance and should only be compared in that context. The S&P 500 was down 19.6% for 2020. The Dow Jones Industrial Average was down 22.7%. The Nasdaq Composite Index was down 13.9%. The Russell 2000 Index was down 30.6%. International equities as represented by the MSCI AC World Ex U.S. Index were down 23.3%. The MSCI Emerging Markets Index was down 23.6%. Fixed Income as represented by the Barclays Aggregate Bond Index ended 3.1% for the year.

Markets have adjusted to life in a COVID world with a significant drop of the magnitude not seen since the Great Recession of 2007-2008. The circumstances surrounding this decline have been unlike anything we’ve experienced in the past. The pace of the decline translated into market dysfunction affecting the liquidity of the U.S. Treasury market, one of the most liquid markets in the world. This in turn cascaded into all credit markets: municipal, corporate, high yield and emerging markets. The injection of liquidity from the Federal Reserve was key to maintaining the proper functioning of the markets and avoiding a credit crunch. In times of market stress, in the rush to raise cash, sellers look for the most liquid investments to sell. In the presence of liquidity issues, market makers widen the spreads between the buy and sell price, otherwise known as the bid/ask spread, reducing market depth. This created a feeding loop into even more volatility. The situation was further aggravated with large hedge funds that were excessively leveraged on their positions coming into this and exacerbating the indiscriminate selling in order to raise cash. Some had employed strategies during times when we had extended periods of very little volatility. That of course came to an end abruptly, catching many off guard to say the least.

The economy has been put in hibernation of our own making as the result of trying to contain the virus. Although there are many projections, no one has a real sense of the economic impact and for how long. Some of this will be dictated by the data from the spread of the disease as well as information related to our handling of this crisis and any mitigation strategies we employ moving forward. We are undoubtedly entering a recession, but that’s a word that simply describes at least two consecutive quarters of negative growth. What we’re experiencing is much more unique than prior recessions. A typical recession may involve a decline of national output of close to 5% over the course of a year or so. In this case, much more will be lost over the next couple of months. The other side of this is we do not know what type of recovery will be possible or how long it will take to return to a semblance of the economy we had prior to this event. The national output can be an abstract number; however, we must remember that there is a real human cost behind that number.

The Federal Reserve enacted an essentially unlimited injection of liquidity to prevent this from turning into a financial crisis. Congress passed an unprecedented amount of fiscal stimulus to help bridge the gap until such time that we can return to some normalcy, whatever that ultimately means. There will probably be more phases to this stimulus. The goal is to sustain things as much as possible until economic activity resumes. The mechanics of doing so are challenging. Although the social distancing and isolation are critical to containing the virus, the impact on the economy is untenable. There is no pause button that can simply put the economy on hold and un-pause it down the road. Some of the damage can be permanent and even when we get a green light to resume life as usual, will there be a new normal? How long will it take for some to become comfortable doing what they used to enjoy doing immediately? It may take a little time to re-adjust. There are many schools of thought as to what that recovery phase will look like. Because this decline in economic activity is of our own making, there is a sense that the recovery will be quick. The U.S. consumer has been the driving force behind the economic expansion of the last decade benefiting from low inflation, strong employment and rising wages. The consumer will play an important role in this recovery. There will however be industries such as the travel industry that will take longer to recover. From a psychological standpoint, it is worth noting that most recessions have been man made and involve a crisis of confidence. This is more like a natural disaster, one that hit everywhere in the U.S. and is global as well. This seems to have brought everyone together and the human spirit remains strong. What we may lack in the ability to restrict the movement of people within this great country, we make up in ingenuity and our ability to respond to the challenge from so many angles. This with tremendous participation from citizens, governments, academics and private sectors around the globe working together in unprecedented ways. This crisis will unite us, and we will hopefully come out of it stronger.

Part of the initial strategy has been to slow the spread of the disease long enough to ramp up health care capacity and allow the flattening of the curve to not overwhelm the health care system. Creative solutions will have to come into play however as there are already areas that have become overwhelmed and in shortage of critical supplies and equipment. Much has been learned from our experience here and from what is going abroad, and much is left to be learned about this silent enemy. Sorting out a sensible narrative out of the myriad of opinions and projections can be daunting at this moment. We should have a lot more clarity in the next few weeks as we learn more and get more data and testing gets ramped up. One of the most significant challenges of this disease is the amount of time an asymptomatic person can spread it around, particularly in such an interconnected world.

From the equity markets perspective, without visibility on the economy and hence the earning picture underlying a lot of companies it is hard for market participants to assess a proper valuation that would help anchor stock prices. In the meantime, gyrations are amplified by the news cycle. It is important to understand that the stock market is a forward-looking mechanism and at some point, will be able to look ahead through the crisis and respond forcefully to the upside long before the economy recovers and we feel like we’re out of the woods on the disease. Therefore, it is challenging to even consider stepping aside in any material way. It would take missing only a handful of days, particularly given the recent volatility to materially impact the long-term picture. Warren Buffett aptly said, “The stock market is a device for transferring money from the impatient to the patient.”

We understand that the information flow will get worse before it looks better, and we are able to see the light at the end of the tunnel. The evolution of the health crisis, the economy and the equity markets although highly interrelated, will have each their own respective curve. The equity markets will typically lead on any positive resolution. We remain vigilant to risks and opportunities within the context of our long-term view.
We are very thankful to serve and guide you during these challenging times. Be safe and be well.