A Trying Month and Quarter
At the risk of adding to your already steady stream of negative news related to the Coronavirus crisis, the well-advertised decline in the global Equity markets is obviously the topic of this missive.
Over the month of March, we saw the broad market indices, as measured by MSCI’s All Country World Index (ACWI), decline by 13.49% bringing the year-to-date decline to 21.37%. While those numbers alone are significant, the intraday and day-to-day volatility were even more extreme. It can be argued that the extremes of fear and indiscriminate selling have likely been reached and, while the market may continue to decline, the movement of stocks within the broad indices will likely be less synchronized. And that is likely the case for the exposures that our Equity allocations had going into this decline and possibly more so for the allocations which we will likely have coming out of this.
Value and Small Cap indices experienced more significant declines. The S&P Large Cap Value Index (ticker RPV) was down over 40% and the S&P 600 Small Cap Index was down over 32% year-to-date at month-end March. While International Developed and Emerging Market Equities had already been lagging US Equity Markets, as we have been noting, they were also down 22%+, with their Value sub-sectors down 25-30%. Given our exposure to these sectors, that put our core Equity portfolios down 27-29%, depending on the exact mix of ETFs.
Is this frustrating? Certainly. Do we think it will persist? For certain sectors, yes. Higher quality companies will be able to weather this storm better than their lower quality peers. The shifts we made mid-month, while at the same time taking losses for tax purposes, have portfolios more heavily positioned in higher quality Large Cap and, to a lesser extent, Small Cap US Equities, relative to a market cap-weighted allocation. The Large Cap names initially lead the market higher and outperformed in the backup. We also expect them to outperform in a recovery. The data tells us this in terms of their long-term strength relative to other sectors, and it makes intuitive sense as Large Cap US companies have tended to dominate their industries globally. We gain exposure to these names in the Momentum and Low-volatility Indices which we buy.
Small Cap names, on the other hand, lagged on the way up and have gotten severely punished on the way down. However, the indiscriminate selling in that space should dissipate and higher quality names should recover first and lead the market recovery in their sector. We bias our Small Cap exposures to indices that have a quality filter, primarily based on profitability or dividend payment.
Now for the pep talk. This type of decline, which is unprecedented in its speed – it was the fastest 30% drawdown in history at only 22 days – is painful. The fact that our positioning underperformed the broad global indices is adding insult to injury. This crisis is different and we would recommend your reading the following piece in the FT here to understand how different it is for financial markets. But even though it is different, our discipline and message to stick with the process are the same.
The average returns from the depths of a bear market have historically been 52%, 89%, and 132%, respectively over 1, 3 and 5-year periods. While we may not yet be at the depth, we believe portfolios are positioned well for the recovery when it inevitably comes, will continue to harvest for tax losses if they present themselves, and will adjust the portfolios quarterly in line with our models.
We will send the performance update for the Fixed Income ETF, FWDB, that we hold for balanced client accounts, under separate cover. This was a success story as its dynamic model avoided a significant drawdown in value during an incredibly volatile month for Fixed Income sectors as well.
Source: Morningstar
