“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the Spring of hope, it was the Winter of despair…”
– Charles Dickens
– A Tale of Two Cities
Much like the main theme of dichotomy in the Dickens literary classic, economies and markets saw a tale of two halves in the first quarter of 2020.
The first half witnessed an extension of all-time highs in global markets and nothing less than stellar economic activity in many parts of the globe, but particularly here in the US. Even with reports of lockdowns in major regions of China due to the spread of COVID-19, US markets displayed strength by advancing to record highs – for the benchmark S&P 500 Index, a closing high of 3386.15 on February 19.
Sixteen trading days later, the S&P 500 would enter “bear market” territory, describing a drop of more than 20%. The rout would continue through March 23, when the S&P 500 would touch below 2200 and close at 2237.40, marking a 33.92% drop in the benchmark index in just over a month and the fastest, steepest decline since the market crash of 1987. While a strong rally ensued in the final days of the quarter, the quarter ended with a -19.60% drop in the S&P 500 and the primary bull market trend that lasted for over a decade – broken.
From an investment perspective, the companies that we own entered this period of uncertainty from a position of strength. While 2019 was a strong year for portfolio returns, it is important to remember that markets were resilient for more than a decade. Corporate earnings were strong, balance sheets were in excellent shape and outlook for future growth was improving.
Even with the above, we began to position the portfolios that we manage in a more defensive stance as we entered 2020. We trimmed some of our holdings, rebalanced portfolios according to strategy and made every effort to ensure that we had ample cash available to clients that regularly take withdrawals in order to fund living expenses. It is important to note that it is our process, combined with some of the technical indicators we pay close attention to that drove these decisions. We admit that we did not foresee in the beginning of this year that COVID-19 would wreak havoc in the economy and markets, but the confidence in our process and indicators has grown stronger as it has.
While we came into this downturn in a more defensive stance with the portfolio actions taken in January, we eliminated and trimmed certain positions in mid-March that we viewed as more challenged in the current and future environment. We also reduced our international exposure in March, leaving us in a more defensive position across portfolios as we begin the second quarter. While our inclination is that the violent, mass liquidation phase is likely over for US stocks, bottoming is a process rather than an event. With so much uncertainty around the path of the virus and the economic toll it will take, our sense remains that a more cautious approach is warranted as we attempt to endure and eventually recover from this.
As we begin the second quarter, economic expectations have been and continue to be slashed drastically. More than 15 million US workers have filed for unemployment in just three weeks, far outpacing anything market participants have ever seen. As COVID-19 spreads throughout the globe, governments are mandating and/or encouraging social distancing, shuttering “non-essential” businesses and essentially shutting off the spigots of economic activity in attempt to “flatten the curve” of this deadly virus.
The monetary and fiscal response has been historically swift and massive. While the Federal Reserve slashed interest rates to the zero-bound, it has also announced massive quantitative easing programs that have dwarfed prior programs that began in the 2008-2009 Financial Crisis. Almost simultaneously, there have been three massive programs passed with near unanimous bipartisan support, including the most recent $2+ Trillion CARES Act – a program aimed at individuals, small businesses, specific industries, such as Airlines and Leisure and State and Local governments to varying degrees. Essentially, the Fed, the Treasury and the US Government have demonstrated the will to do whatever it takes to stop the impact of COVID-19 from an economic perspective and this has been historically impressive. While most have accepted the reality that we are in a Global Recession, the debate has now shifted to the depth and duration of this severe economic shock.
From a market perspective, history offers little in terms of a guide, as global pandemics on the scale of COVID-19 have been thankfully scarce. We can draw context from other event-driven bear cycles, particularly the market crashes of 1929 and 1987, that were somewhat comparable in terms of velocity and severity. While 1929 was largely caused by excessive leverage, it did ultimately lead to the Great Depression. It also led to increased regulation, the formation of the Federal Reserve, the Securities and Exchange Commission (SEC) and many market reforms that continue to regulate firms and protect investors today. In addition, social safety nets such as welfare and Social Security were created. In 1987, portfolio insurance was largely to blame and while investors suffered massive damage in the period, it only led the economy into a mild recession, with monetary and fiscal response much more muted.
Even as we begin the quarter in a defensive posture, we do envision our process leading us to make new investments in both current and new companies. Our plan is to do so in a measured and scaled way. It would not surprise us to see markets retest the lows of March to some degree, even while we are certain many individual stocks may have already bottomed. Given the level of economic damage, particularly to small businesses, our view is that this is unlikely to be short-lived. We trust the technical indicators that led us to be more defensive prior to this downturn will eventually point to improvement and patience is required in the meantime. When we do make new commitments, our focus will be on companies with strong industry positions, balance sheet strength that will allow companies to endure this period of extreme weakness, run by capable management teams and attractive valuations.
It is our strong view that while we will recover from this, it may take more time than many expect. The path of COVID-19 will dictate economic outcomes – as testing improves and the spread of the virus peaks, we can all begin to better understand the economic path forward. Reopening of the economy will require a comprehensive plan on a sensible and defined timeline that includes rapid and reliable testing, contact tracing to quarantine selectively and alert those that may have been exposed.
We are encouraged by the progress in the scientific community and the ability to develop testing capability and capacity in a tremendously compressed period of time. We have the utmost confidence in the abilities of the Biotechnology and Pharmaceutical industries to develop treatments and ultimately vaccines, but it is very important to understand that this will take time in order to be done properly.
As mentioned in our opening, there will be major shifts to the landscape of virtually every area of study – most notably geopolitics, economics, education and biology. Just as every other major global event has shaped history, so too will this. In time, we will have a much better understanding of these implications and will share our thoughts as these unfold. In the meantime, Biondo Investment Advisors as a company will be focused on helping our clients, helping our employees and helping the communities that we serve. On behalf of everyone here, we wish the best for you and your families and remain committed to doing the best we can on your behalf.
Joseph P. Biondo
Chief Executive Officer
Chief Investment Officer
Sources: Bloomberg, Brogan Research
The information set forth regarding investments was obtained from sources that we believe reliable but we do not guarantee its accuracy or completeness. Neither the information nor opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Past performance does not guarantee future results.