In March 2020, we experienced one of the sharpest market declines ever recorded. However, over the past six weeks, global equities have rebounded strongly from their mid-March lows. For example, global equities (as measured by the MSCI All Country World Index) are up 10% since April 1 and are now down a more palatable 13% year to date.
As we look forward to the continued healing of global economies and markets, we would like to take a moment and point out that investors should not expect an immediate return to previous highs. Nor should we expect all investment assets to perform in unison. Considerable uncertainty remains as states and nations begin to reopen. Virus-related closures have had a disproportionate impact across sectors and industries. The course of the virus will undoubtedly influence global economic recovery and corporate earnings. Additionally, significant questions surrounding future consumer behavior have yet to be answered. Although we currently believe that mid-March will mark the lows for 2020, investors should expect continued market volatility, a series of advances followed by pullbacks, and uneven performance across asset classes.
We are strong advocates of diversification and believe it is important to point out that there has been a large variance in performance between the various asset classes and investments we own on behalf of our clients. In fact, the divergences in performance among domestic small and large capitalization stocks, between growth and value styles and between domestic and international stocks have been noteworthy.
For example, let us compare the U.S. Large Cap Growth sector of the equity market with U.S. Small Cap Value. Large Cap Growth is heavily weighted toward multi-national technology companies and led by the FAANG stocks (Facebook, Amazon, Apple, Netflix & Google). The virus-related public health crisis and subsequent economic shutdown has had, to this point, modest impact on many of these businesses. In fact, some (i.e. Netflix & Amazon) have benefited. As a result, the U.S. Large Cap Growth index is flat for the year, even though the S&P 500 is down considerably. Now compare this to Small Cap Value stocks. Smaller businesses are more exposed to the business cycle and therefore especially vulnerable during times of recession as they tend to be less profitable and more susceptible to business failures. So, despite the rally we have seen over the past few weeks, the Small Cap Value index is still down 30% in 2020.
The same disparities can be seen when we look inside an index. Looking at the S&P 500, we note that the technology component is up 3% for the year (although heavily weighted to just a few mega-cap stocks). While technology is the best performing sector within the S&P 500 this year, followed closely by health care, energy has been this year’s worst performing sector to date. Recessions lessen energy demand, and OPEC’s inability to initially agree on production cuts sent the price of oil plummeting earlier this year. Today, the price of oil is down 60% from where it finished in 2019.
Within the fixed income markets, we also saw large variances in performance, although in many cases it was driven by liquidity concerns. The Fed is in the process of buying investment grade bonds, commercial paper, asset-backed securities, and more, which should shore up the fixed income markets. However, incredibly low interest rates make fixed income, especially more traditional fixed income, a more challenging place to invest.
These examples point out the wide differences in performance that exist in both equity and fixed income markets, and we anticipate that this trend will continue to be the case for some time.
Accordingly, we recently rebalanced clients’ portfolios towards more active (vs. passive, index related) investment management. We believe there are strong alpha -generation (risk-adjusted returns above a comparable market index) opportunities available from high-quality, active managers that can navigate in an environment where large performance differences between size, style, and sector exist. When choosing these managers, our due diligence process focused on long-tenured managers/teams that have demonstrated value-add through their stock picking ability while avoiding significant concentrations in any one area of the market or in any one particular group of equities. Diversification remains very important during these turbulent times, and we are avoiding strategies that make “big bets.” Instead, upside/downside capture (measures of comparable performance in up and down-market environments vs. a given benchmark index) weighs heavily in our decision making.
Gries Financial Partners customizes each client’s portfolio to their specific needs and our recent move towards active management reflects our view of the underlying economic and market realities. Should you have questions or would like to discuss changes you may see in your portfolio, please do not hesitate to contact us at email@example.com or 216-861-1148.