We’re an investment advisory firm, and it’s our duty to provide perspective on the capital markets as it relates to our clients’ portfolios. However, we aren’t blind to the enormity of the human tragedy with respect to people’s health and individual economic situation – our hope is that you remain healthy and safe during this trying time.
Review of 1st Quarter
Let’s begin with the data on market returns. Stocks fell by 20% in the first quarter. International stocks dropped by a bit more – developed markets and emerging markets fell by 23% and 24%, respectively. Bonds rose by 3%, but it was a combination of two highly distinct bond markets. Treasury bonds increased in value by 7% (heavily influenced by long-term Treasuries) while investment grade corporate bonds fell by 4%. Non-investment grade bonds (high yield and emerging markets) performed even worse.*
Our Long-Term View for Stocks and Earnings Forecast
For those of you who haven’t been reading the periodic posts over the past several weeks on our website, we’ll restate our general thesis. At some point in the future – perhaps as little as six months or perhaps as long as 18 months – the majority of the crisis will be behind us. At that point, companies will begin to approach previous levels of profitability, and market values of stocks should start to return to close to pre-crisis prices. We’ve been consistent with this view since the beginning of the pandemic, but now there’s some widespread data to support this.
Standard and Poor’s produces an aggregation of security analysts’ earnings estimates for the next two years on a quarterly basis. We’ve referenced that data several times over the past few years. Not surprisingly, earnings are expected to fall for the first two quarters of this year – by the second quarter, earnings are predicted to decline by 12% relative to fourth quarter of 2019. But there’s expected to be a lot of differentiation across sectors. Energy profits are predicted to be negative in the second quarter, and consumer discretionary (which includes travel and restaurants) earnings are expected to decline by 40%, while health care and utilities companies are anticipated to increase in profitability. After the mid-year point, the financial picture is expected to be rosier. Beginning in the third quarter, profits are expected to start to rebound, and by the 4th quarter, overall profits are expected to be higher than they were one year earlier. That growth is expected to continue throughout 2021.**
There were a lot of numbers in that paragraph – so let’s contemplate for a moment. My gut says a complete earnings rebound within 10 months of the beginning of this crisis is on the optimistic side. But these are not wild guesses by amateurs – security analysts get paid (a lot) based on the accuracy of their forecasts, and lest you think they’re overly positive people, on average they tend to underestimate earnings. Moreover, there’s a disproportionate number of analysts working in Manhattan, and no area of the country is more aware of the impacts of the coronavirus. Regardless of exactly when the rebound will occur, their outlook is consistent with the idea of an eventual recovery, and from a long-term investment strategy perspective, it suggests that now is not the time to sell stocks.
We usually put this section much earlier in our commentary, but the broad economic data is basically useless. The most recent GDP data is from the 4th quarter, so does it really matter? On Friday (April 3), many financial journalists felt compelled to comment that unemployment had risen to 4.4% -- that data
is based on average employment throughout March. Does anyone really believe only 4.4% of Americans are currently out of work? For completeness, we provide our typical economic snapshot showing key economic and market indicators (as of March 31, 2020) without further commentary.***
Similar to the more important medical research efforts, financial analysts are starved for relevant up-to-date data. The extreme volatility in both stock and bond markets is caused in part by the lack of solid relevant data. Despite our positive long-term outlook, that high daily volatility will continue for many weeks.
All the bond managers with whom we’ve spoken have described the complete lack of rationality in corporate bond prices relative to government bonds. In theory, the difference in yield between a corporate bond and a Treasury bond of similar maturity is solely based on the potential of default of that corporate bond. Near the end of March, the implied default rates per year for various types of corporate bonds based on the yield differential were mind-boggling. While those corporate bond yields have decreased over the past week, there still seems to be underpricing of most non-Treasury bonds. We anticipate a similar recovery on these bonds as we will see in stocks.
It’s been a turbulent time, but we’ve seen stock market turbulence in various degrees over the past two decades. The best policy during those volatile times was to maintain a consistent long-term investment strategy, and we believe that remains the case today.
There are many examples of this crisis bringing out the best in people, as there have been touching displays of bravery and kindness. Unfortunately, the fear caused by the pandemic can also bring out the worst in people, and there are many internet fraudsters tugging at people’s concern and heartstrings. Please be particularly vigilant when receiving messages from unknown sources by text, email or social media. Particularly, there have been cases of fake messages and alerts about opportunities to buy N-95 masks and possible exposure to COVID-19 through a personal contact, with links or attachments that if opened, will allow the sender to steal information from your computer.
I’m particularly proud of the efforts of all our employees. As a group, they’ve faced many of the hardships you’ve dealt with while they’ve been working from home – concern over elderly parents, monitoring their children’s on-line education, and even a cancelled wedding. At the same time, they’ve been particularly dedicated to the needs of our clients, responding to requests and questions as promptly as possible, and proactively reaching out to clients when appropriate. We have a high standard when it comes to client service, and they’ve lived up to that standard during these difficult times.
* Source of returns is Morningstar, Inc. Past performance is not indicative of future results.
** Source: S&P Dow Jones Indices
*** Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board
This update is provided by Savant Investment Group, LLC (“SIG” or the “Firm”) for informational purposes only. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. No portion of this commentary is to be construed as a solicitation to buy or sell a security or the provision of personalized investment, tax or legal advice. Certain information contained in this report is derived from sources that SIG believes to be reliable; however, the Firm does not guarantee the accuracy or timeliness of such information and assumes no liability for any resulting damages. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.
SIG is an SEC registered investment adviser that maintains a principal place of business in the State of California. The Firm may only transact business in those states in which it is notice filed or qualifies for a corresponding exemption from such requirements. For information about SIG’s registration status and business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov.