Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist
Coming into the new year, markets took a reasonable pause given the stellar returns of the prior year. However as COVID-19 metastasized from a regional health crisis into a global pandemic, it precipitated a dramatic rise in the level of uncertainty in the global markets that we have not seen since the Global Financial Crisis in 2008. Unlike trade wars or sovereign debt crises, the impact on global economic activity of an escalating worldwide lockdown defied easy quantification, and the market reaction was severe. Daily volatility increased significantly, and it was very much a trading oriented market. In the short-term, “where” one has been invested, i.e. how you have been positioned, has been much more relevant to returns than “what” one has invested in. The fact that valuations across a number of asset classes were elevated exacerbated the selling pressure once the correction began. Trading in passive vehicles appears to have caused some dislocations in the markets as well. Liquidity has been a challenge in the fixed income markets with even US Treasuries feeling the effects.
The Russell 3000 Index finished the quarter with a return of -20.9%, erasing a significant amount of the prior year’s gains. Even in the downturn, large cap stocks continued to perform better than small caps. The Russell 1000 Index returned -20.2% while the Russell 2000 Index returned -30.6%. International markets performed largely in-line with US markets with the difference in returns due to the relative strength of the US dollar. The developed market MSCI World ex USA Index returned -23.3% while the developing market MSCI Emerging Markets Index returned -23.6%. Although there were pockets of dislocation and stress in lower grade securities, the fixed income markets fared much better, particularly with the incredible drop in US Treasury yields (US 10 year yields fell 125 basis points during the quarter!). The Bloomberg Barclays US Aggregate Index returned +3.2%.
At the Sector level in the US, cyclical and economically-sensitive areas fared the worst in the market rout with Energy (-51.9%) crushed under the twin pressures of a sudden global economic stop and an oil price war between Russia and Saudi Arabia. Financials (-32.7%), Materials (-28.0%), and Industrials (-27.8%) were other significant decliners. Technology (-12.9%), Health Care (-13.1%), and Consumer Staples (-13.4%) held up relatively well in comparison. Outside of the US, Energy (-38.0%) and Financials (-31.0%) were also the weakest segments of the market. Health Care (-8.7%) and Communication Services (-13.9%) were the relative outperformers while Technology (-17.8%) did not hold up as well given the larger proportion of cyclically-sensitive semiconductor names.
No countries were spared in the market sell-off with all posting negative returns in aggregate. Denmark (-7.7%), China (-10.2%), and Switzerland (-11.1%) were the best relative performers while Brazil (-50.2%), Colombia (-49.7%), and Greece (-45.1%) were the worst performers.
Market volatility, which had been largely dormant for the last several years, soared with March seeing the highest level in the history of the VIX index. Trade volumes exploded and market breadth was significantly negative. At the factor level, Value and Smaller Size were significantly negative, showing no recovery even with the sharp turnaround in market direction. Stability, Quality, and Momentum were positive. Even in the drawdown, market leadership remained narrow leading equal-weighted portfolios to underperform market-cap weighted portfolios.