Euphoria and Panic
During the first quarter equity markets had one of their worst ever returns. The depth and breadth of the carnage were vast and nearly unprecedented!
Figure 1 shows the S&P500 since Sept. As you can see we had a period of euphoria, based on Chinese/US trade war détente and the expectations for global economic growth. Things got too frothy and expensive with expectations too high.
The spread of the Coronavirus triggered the downturn. First in China, and now worldwide, particularly in the US where we were slow to begin testing.
Markets, like nature, abhor a vacuum. This is a fundamental rule of investing. Rarely are there times that markets are completely unsupported. An unquantifiable problem is one such time. When markets don’t know the size of the problem and can’t estimate the econ impact, there are few buyers.
We view the market decline in 3 phases. In the first, there was simply the fear of the unknown as I just mentioned. Then, there was a fear of credit problems. During this phase credit markets became dysfunctional. This is where the real risk lies because it can cause a domino effect if any one large institution fails. This is where we were 2 weeks ago before the Fed stepped in on March 24th with unlimited funding. This, in concert with the US government’s policy responses and funding, has stabilized markets for now.
Figure 2 we have yields on the US 10 Yr Treasury.
As you know, this is a safe haven asset. Investors flock here when they see other assets as too risky, much as we see now. So as investors bid the price up, the yield falls.
We began the year with a yield of 1.9% and have dropped to 0.67% at quarter-end, an incredible move!
The bond markets have led the way this year, sniffing out the problems well before equities (as is typically the case).
We’ve been watching closely too, and we’ll point out later how we’ve adjusted the portfolio.
But suffice it to say, that fixed income is the key to what happens from here.
Here are the returns YTD quarter-end:
So we’re never happy with negative returns but we are happy when we are able to preserve your capital. And on a relative basis, that is what we have done. The losses in our strategies are a fraction of the overall equities markets and a 60/40 mix of equities and fixed income.
This is why we are proponents of the active approach to investing. Hoping and holding down here doesn’t feel great.
You have heard us preaching about high valuations and risk for a while. Well, its times like these when being prudent and risk-averse matters.
It is likely that once the Coronavirus fears have passed we will get a substantial bounce. The key though will be how much economic damage has been done and how long will the recession (hopefully not depression) last. It is far too early to answer those questions. For now, we are working mostly on capital preservation.
There is still plenty of volatility to come. But we’re working diligently to earn the best risk-adjusted returns possible
Lastly, a disclaimer, every client account is unique and does not follow the strategy above exactly. So results will vary.
Figure 4 is an example of our positioning, using the Stableford 50 Plus. In it, we have 3 lines: red for cash, blue for net equities, and orange for bonds.
I’d divide this into 3 phases
In the first phase through mid-February, there are roughly 60% net equities, mid 20% bonds and cash under 10%. While it looks like the percentages aren’t moving, within the investment choices things are happening. First, the bonds are becoming longer duration, a fancy way of saying longer-dated. This just means that they move up in price more for each % drop in yield. This was our hedge as we believed trouble might be afoot, and if it came the Fed would be lowering rates. We also moved to nearly all government bonds and our corporates which have higher credit risk, a move that proved to be prescient.
In the second phase (which is the period where the blue line falls from mid-February to mid-March) there are 2 things to highlight. First, we began selling equities. We held on to some core positions, but mostly we were sellers. We also began to heavily hedge equities here for two reasons: 1 to avoid the impact of the downturn, and two, to avoid selling and taking capital gains on long-held positions (which we’d rather hold and avoid creating taxable gains). We also began to sell down bonds as rates had fallen so much there was not as much upside left as when we began.
In the third phase, the Fed stepped in with unlimited QE or buying of certain bonds, and the government stimulus. This has helped put a floor under the really big downside risk, for now, so we have started to increase our net equity exposure. Some risk still remains though. Will the credit markets be ok when borrowers stop paying on loans? Will the government stimulus be enough? We hope so, but it isn’t clear yet. So we are prudently buying names with less debt and limited to high-risk areas. As things improve, we’ll begin to increase the total exposure.
Are you interested in making portfolio changes or getting a more in-depth analysis? Contact Stableford today by calling 480.493.2300 or simply request a free trial of our Market Blast.
Disclosures: Stableford Strategy Descriptions
- Stableford 50 Plus seeks to invest in a diversified portfolio of high-quality securities in sectors with the largest opportunity for appreciation while targeting risk levels below that of the overall market. Inception date 1/1/2015
- Stableford ETF Plus seeks to invest in a diversified portfolio of high-quality securities, in sectors with the largest opportunity for appreciation while targeting risk levels below that of the overall market. Inception date 2/1/2016
- Stableford ETF—Conservative seeks to invest in a diversified portfolio of high-quality securities, primarily ETFs, with opportunities for appreciation, balanced with capital preservation. This strategy targets risk levels below that of the overall market. Inception date 1/1/2015
For more information regarding the strategies’ returns since inception, please call Nathan Faldmo at 480 939-3410.
This market commentary was written and produced by Stableford Capital, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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