- The $349 billion in U.S. stimulus funds allotted for small businesses in late March was depleted in a matter of weeks — requiring Congress to authorize an additional $321 billion in funding to keep the program in place.
- We think this real-life, albeit metaphorical, black swan presents an opportunity to become a more informed investor.
Stock markets around the world continued to face off against COVID-19 throughout April as both equities and infection rates underwent near-relentless expansions. The official infection rate more than tripled during the month to over three-million cases worldwide — and is assumed to be a dramatic undercount given the lack of available testing. Coronavirus lockdowns were therefore maintained around much of the world. Nevertheless, stocks advanced globally almost without exception during the month as forward-looking investors spotted sources of encouragement — including plans to slowly reopen economic activity in some regions; developments in the race for COVID-19 treatments and vaccinations; and much lower securities pricing after the selloff in February and March.
U.S. stocks outperformed other major developed markets in April as the S&P 500 Index generated its highest one-month return since 1987 and volatility was nearly halved (according to the CBOE Volatility Index, or VIX Index). While the U.K., along with most European countries, Japan, and emerging-market giant China lagged the U.S., each finished high above their respective average one-month returns (according to country-level components of the MSCI ACWI Index).
U.S. and U.K. government-bond rates fell across all maturities during the month. In the eurozone, long-term rates fell as shorter- and intermediate-term rates increased somewhat. The West-Texas Intermediate (WTI) spot oil price plummeted below zero U.S. dollars per barrel for the first time in history — briefly touching -$40 per barrel in April as its futures contract for May delivery neared expiration; the June futures contract traded between $10 and $20 per barrel through the end of April. Despite a 23-nation agreement led by the U.S., Saudi Arabia and Russia to cut production by 9.7 million barrels per day, oil inventories were projected by the U.S. Energy Information Administration to reach full storage capacity at some point in 2020.
In the U.S., the $349 billion in stimulus funds allotted for small businesses through the Paycheck Protection Program (PPP) in late March was depleted in a matter of weeks — requiring Congress to authorize an additional $321 billion in funding by mid-April to keep the program in place. Larger companies, some publicly traded, received loans from the program, prompting public criticism and demands from Treasury Secretary Steven Mnuchin that those companies apologize and return the loans (which some did); he also said that loans extended under the program for above $2 million will be subjected to an audit. The Department of Justice also announced it would investigate instances of fraud associated with the PPP. This follow-up appropriation drove the U.S. annual deficit to $3.7 trillion, blowing through the previous record of $1.5 trillion set in 2010.
President Donald Trump issued an executive order in April to suspend immigration for 90 days, denying work visas for most types of jobs. He also invoked the Defense Production Act of 1950 in an effort to force meat-processing plants to remain open, despite labor unions’ concerns about the danger of working in close quarters during the pandemic. The state-to-state outbreak response continued to vary widely, with some states (like New York) extending lockdowns into May while others (like Georgia) started to allow non-essential businesses to open in late April.
The U.K. government continued to build out its Coronavirus Job Retention Scheme during April, extending the program by another month until the end of June. It also increased the ceiling on a loan-guarantee program, enabling companies with annual revenues above £45 million to access support if they’ve been impacted by the lockdown period (which was extended by another three weeks). Prime Minister Boris Johnson emerged from his personal battle with COVID-19 in April, having been hospitalized in intensive care and temporarily deputizing Foreign Secretary Dominic Raab to fulfil his role while incapacitated.
Elsewhere, Germany began reopening on 20 April, with plans for a phased return to schools starting in May, and clear benchmarks for returning to lockdown in the event of resurgent spread of COVID-19. New Zealand declared that it eliminated widespread community transmission of COVID-19 as at 27 April, enabling citizens to start moving more freely and non-essential businesses to begin reopening.
The International Monetary Fund (IMF) forecasted the worst recession since the Great Depression as a result of COVID-19 containment measures, and announced that half of all member countries have requested a bailout from the lender of last resort. Argentina skipped a $503 billion debt payment due in late April, starting a 30-day clock toward default, shortly after a group of international creditors rejected the government’s latest plan for restructuring its sovereign debt.
Manufacturing activity collapsed during April across the U.S., U.K. and eurozone after contracting at a relatively mild pace in March. Their respective services sectors were hit much harder than manufacturing in March as lockdowns took effect, and were not spared by that fact as conditions continued to tighten sharply in April. Preliminary data indicate that services activity contracted more sharply in the U.K. and eurozone than in the U.S. during April.
- U.S. jobless claims climbed to approximately 30 million from mid-March through the end of April, representing that roughly 20% of the U.S. labor force has applied for unemployment insurance. Overall economic activity contracted by an annualized 4.8% rate during the first quarter for the lowest reading since the fourth quarter of 2008.
- Retail sales plummeted 5.1% in the U.K. during March and 5.8% year over year.
- Overall eurozone economic activity contracted by 3.8% during the first quarter — the worst decline since the EU began keeping records for euro area gross domestic product (GDP) in 1995.
- The Federal Open Market Committee met in late April and announced no new changes. In a post-meeting press conference, Federal Reserve (Fed) Chair Jerome Powell pressed lawmakers “to use the great fiscal power of the United States to do what we can to support the economy.”
- The Bank of England’s (BoE) Monetary Policy Committee did not meet during April. BoE Governor Andrew Bailey sought to reaffirm the central bank’s commitment to avoiding monetary financing (that is, purchasing government debt to fund deficits) by assuring that any expansion in the government’s overdraft would be repaid by the end of 2020.
- The European Central Bank (ECB) lowered the rate on its targeted long-term refinancing operation (TLTRO III) further into negative territory following its end-of-April meeting, effectively paying banks to lend. The ECB also announced a new program called the pandemic emergency longer-term refinancing operations (PELTROs) to help facilitate proper functioning of money markets.
- The Bank of Japan committed to open-ended purchases of Japanese government bonds in an effort to keep yields low and stable following its late-April monetary-policy meeting. It also announced a ramp-up to its purchases of corporate bonds and commercial paper, with a target of ¥20 trillion.
- The People’s Bank of China decreased the rate on its one-year medium-term lending facility to the lowest level since the the program’s inception more than five years ago. The central bank also cut its benchmark loan prime rate (one- and five-year rates). Additionally, a cut to bank reserve requirements came into effect in mid-April, freeing bank capital reserves for lending.
The extraordinary rebound in U.S. stocks during April was fairly even across large- and small-cap equities despite the much greater decline for small caps during February and March. Growth-oriented stocks continued to lead value-oriented stocks during April. In this environment, our U.S. large-cap strategies1 trailed their benchmarks’ rebound due to underweighting stocks with the most expensive valuations. Our small-cap strategies performed well, benefiting most from stock selection in financials and information technology and an overweight to consumer discretionary. Exposure to stability-oriented stocks detracted amid the sharp rally. Our international developed-market equity strategy handily outpaced its benchmark in April. The top contributors were selection in and (to a lesser degree) an overweight to information technology, followed by selection in healthcare, industrials and consumer staples; overall positioning in real estate detracted. From a country perspective, the biggest contributors were selection in the U.K. and Germany along with an allocation to Canada. An underweight to Australia detracted (despite positive selection), as did overall positioning in Japan. Our emerging-market equity strategy also outperformed its benchmark during April due to selection in information technology and consumer discretionary, while positioning in financials detracted. At a country level, selection in Taiwan and Brazil contributed most (overcoming an unfavorable overweight to Brazil); an underweight to Saudi Arabia detracted.
Our cored fixed-income strategy outperformed its benchmark during April as non-government fixed-income sectors led comparable U.S. Treasurys. Overweights to the short and long ends of the yield curve added to performance as Treasury yields declined (yields move inversely to prices). An overweight to corporates benefitted from optimism that we may be nearing the peak in COVID-19 cases. Overweighting asset-backed securities (ABS) also contributed, as did a significant allocation to student loans. An overweight to strongly-performing agency mortgage-backed securities (MBS) added to returns; selection in specified mortgage pools (that is, groups of mortgages with similar characteristics that are held as collateral for issuing MBS) was also beneficial, as Fed actions helped alleviate questions about support for the market. A higher-quality bias within commercial MBS (CMBS) also enhanced returns. Our high-yield strategy underperformed its benchmark during April primarily on an allocation to collateralized-loan obligations (CLOs). An overweight to and selection in media also detracted, as did an underweight to and selection in energy. The strategy benefited from positioning in financial services as well as selection in healthcare, technology and electronics. Our emerging-market debt strategy performed in line with its benchmark during the April rebound. An overweight to local-currency-denominated Russian debt contributed, while underweights to higher-quality markets like Thailand, Saudi Arabia and Poland detracted.
Manager Positioning and Opportunities
The path toward economic recovery will likely depend on a decrease in the spread of COVID-19 and an effective response from governments to the dual health and economic crises. Investors have begun to adopt a positive stance with possible help from a vaccine and a belief that the worst is over, but we expect volatility to remain elevated — at least until successful containment of the virus allows for a reopening of the economy. Within our large-cap strategies, we continued to underweight some of the largest-capitalization stocks in favor of more attractively-valued opportunities further down the capitalization spectrum. We remained overweight to healthcare, consumer staples and financials due to the combination of their expected profitability and reasonable valuations. Within small caps, we favored value-oriented stocks (given how extremely inexpensive they’ve become), as well as stability-oriented stocks (due to our cautious stance). Our international developed-market strategy retained overweights to information technology, communications services, industrials and healthcare. Real estate, utilities and energy remained underweight. Our emerging-market equity strategy maintained an overweight to information technology and industrials, along with communication services. Financials, real estate and materials were still underweight. Regionally, we were overweight Latin America (primarily via Brazilian consumer-related stocks) as well as South Korea and Taiwan (for their exposure to technology companies). China and Malaysia were underweight (primarily via financials), as were Saudi Arabia (high valuations and poor oil-market dynamics) and South Africa.
With long-term yields remaining near historically low levels, our core fixed-income strategy reduced its overweight to the 25-to-30-year segment of the yield curve and increased positioning in the 7-to-10-year segment. Within core fixed income, we increased an overweight to the corporate sector as spreads widened to post-crisis extremes, and record new issuance provided the opportunity to add exposure at discounts. Overweights were concentrated in industrials and financials, particularly within the consumer non-cyclical subsector of industrials; a small overweight to energy remained focused on the pipeline industry. Overweights to ABS and CMBS were maintained given their competitive risk-adjusted yields, with an ongoing emphasis on higher-quality holdings. We retained an allocation to non-agency MBS, and added to an agency MBS overweight as the Fed moved to support this normally high-quality market. Within high yield, our strategy remained active in both the primary and secondary markets. The largest active position was still an allocation to CLOs, followed by a large underweight to energy. Other underweights included telecommunications, automotive, consumer goods, healthcare and services; overweights included leisure, media, retail, basic industry and insurance. Our emerging-market debt strategy was underweight higher-quality countries in order to fund positions to higher-yielding areas that we believe stand to generate strong returns in a recovery from a lower-priced starting position. We retained a small overweight to local-currency assets, which moved close to neutral during April. Our top country overweights were Mexico, Ukraine and Israel, while top underweights were Philippines, Poland and Taiwan.
Black swans, once largely presumed a myth because only the white variety was ever observed in nature, have become symbols of events that are exceptionally rare in occurrence and severe in impact. Today we are confronted with a black swan in the form of a pandemic, as COVID-19 continues its rapid spread and causes financial markets to plunge across much of the world.
The sudden and widespread stop in economic activity by government fiat is something that has never before been experienced on such a scale. The ultimate impact on GDP is truly anybody’s guess. The first quarter of 2020 saw an annualized decline of 4.8% in the U.S. The second quarter will likely be one for the record books; Wall Street economists forecasted a quarter-to-quarter annualized decline ranging from an average of about -25% to as low as -42% as of early May.
National governments have been quick to respond. All central banks are in crisis-fighting mode, having learned valuable lessons during the 2008-to-2009 great financial crisis, re-establishing unconventional bond-buying programs and creating some new facilities to expand the types of accepted collateral in order to extend cash to companies that need it.
The Fed and other leading central banks have moved with an alacrity and forcefulness that we find commendable. But central banks cannot single-handedly support this economic shutdown. In our view, fiscal policy — in the form of direct income support, tax deferrals, loan guarantees and outright bailouts of industries badly damaged by the halt of economic activity — must be the prime tool used to conduct the response to this crisis.
The fiscal response is occurring with a speed and decisiveness that has seldom been seen. The U.S. Congress passed into law a fiscal response that should easily top 10% of GDP — meaning that the overall deficit this year in the U.S. could approach 15% of GDP. Other developed countries are looking to pursue a similar strategy of massive income support and liquidity injections. Germany, a country that typically keeps its wallet closed, is setting the example for Europe. The government has begun to implement a package equivalent to a whopping 30% of the country’s GDP, counting contingencies. Since Germany has built up large reserves in its existing income-support program, the supplementary budget is expected to push its on-budget deficit only toward 5% of GDP in 2020 following several years of surplus.
Few other countries in Europe have the fiscal strength of Germany. Italy, the European epicenter of the virus, will be particularly hard-pressed to do all that is necessary to stabilize its economy. Italy’s government debt-to-GDP ratio is already well above that of other major European countries.
In our view, a financial crisis can be averted in Europe if the ECB backs up the debt. This is now-or-never time for the EU and eurozone. The stronger countries must come to the aid of the weaker, or else face an intensified popular backlash that could threaten the unity of the economic zone. Unfortunately, Germany and the Netherlands have not yet answered this call to rescue, and are standing in the way of the EU issuing “corona bonds.” We anticipate this opposition will ultimately melt as the disaster continues to unfold.
The onslaught of developments presented by the spread of COVID-19 and a simultaneous collapse in oil prices has forced financial markets to recalibrate prices sharply as expectations about different industries and the overall economy shift at a breakneck pace. Investors should gain some reassurance, however, from the fact that a virus-containment-induced earnings recession is generally only expected to last a couple quarters or so. If market prices are based on a long-term, multi-year expectation, then this fallout should represent a relatively small part of the market’s forward-looking focus.
We are grateful that the chaotic trading in March has eased considerably, thanks to liquidity provided by central banks and fiscal packages offered by governments around the world.
Only time will tell whether markets have sufficiently discounted the pain that lies immediately ahead. We have to be cognizant of the fact that earnings estimates will be coming down hard — maybe by 40% to 50% on a year-over-year basis — over the next two quarters. These waterfall declines in earnings could drag equities down with them, but likely not to the same extent. It all depends on how willing investors are to look beyond the valley. If there is a belief that the fiscal and monetary measures taken in the past two weeks will successfully prop up the global economy, then markets should prove resilient. We think a great deal of volatility is still ahead of us, but perhaps not to the extent of the February-to-March experience. Indeed, if there are signs that the infection rate is beginning to peak in Europe and the U.S., it may not matter at all where earnings go in the near term. Investors will likely bid stock prices higher in anticipation of an economic recovery, as they almost always do.
During periods of chaos in financial markets, investors often picture professional portfolio managers frantically trading in an effort to avoid the worst of the carnage while seeking opportunities to profit. At SEI, that reality couldn’t be further from the truth.
With a pandemic crippling the global economy and an oil glut exacerbated by suspended activity around the globe, we find ourselves in an environment almost completely void of reliable information — which, to us, makes frantic trading an especially unwise approach to financial stewardship. So, what are we doing?
We stick to our investment philosophy and process, maintaining our view that diversification is a sound approach over full market cycles, which include bull markets (some of which last for more than a decade) and bear markets (which can vary in terms of length and severity).
Right now, as always, we are exploring how to deliver as diversified a portfolio as possible to all of our investors regardless of their risk tolerance. We’re considering the known risks inherent to the capital markets as well as the uncertainty that comes with any long-term investing plan, such as the black swan we’ve encountered in 2020.
We build and maintain long-term-oriented portfolios by being attuned to the evolving correlations, or relationships, between asset classes. We believe our strategies are robust and built to handle the kinds of challenges presented in today’s environment.
With this in mind, what now?
For one thing, we think checking your portfolio’s balance every day is about as helpful as watching the news these days. It won’t do anything to ease your nerves. At a portfolio level, we encourage investors to stay diversified and avoid short-term trading in these volatile markets.
If you are a goals-based investor — and your portfolio is aligned with your goals, time horizon and risk tolerance—be patient. Time should be on your side.
You’re seeing a real-life, albeit metaphorical, black swan. Use this experience to become a better, more informed investor. We will continue to monitor economic and financial-market developments and provide our insight to help you achieve that goal.
1Individual holdings will differ between strategies. Not representative of our passive strategies.
For a glossary of terms and index definitions, visit global indexes and investing terminology.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding SEI’s portfolios or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.
There are risks involved with investing, including loss of principal. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments.
Diversification may not protect against market risk. Past performance does not guarantee future results. Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI).