Coronavirus – Market Uncertainty Persists
Coronavirus: It’s impossible to reflect on financial markets in the first quarter of 2020 without referencing that word. This disease, COVID-19, and responses from governments around the world have left deep footprints on our global society and financial markets and will continue to do so for some time to come.
Fears about what the COVID-19 pandemic will do to human health and the economy continue to mount, especially as nations, states and cities shutter schools, businesses, sporting and cultural events, and civic functions. Several central banks, including the U.S. Federal Reserve, have cut interest rates significantly and are injecting cash into economies in the form of bond purchases. Businesses have arranged for those workers who can work remotely to do so, and the U.S. government has enacted a $2.2 trillion fiscal stimulus package to lessen the depth of a forthcoming recession.
Financial markets have plunged and soared on daily news, but during the first quarter, the plunges far outpaced the recovery days. The virus’s impact on asset performance has been widespread, from equities to fixed income and from domestic to international markets.
Unprecedented – A Review of U.S. Markets During the First Quarter
One of the words we’ve heard most during the COVID-19 crisis is “unprecedented.” While seemingly overused, it clearly describes the times we are enduring. Current financial market activity could also be described as unprecedented, or, at a minimum, extremely volatile.
Equity markets experienced the fastest retreat from a market high to a bear market in history, as the S&P 500 Index sold off nearly -27% in the 22 days between February 19 and March 12, ending the market’s longest bull run at 11 years. Small cap companies were hit even harder as the Russell 2000 Index was down -41% from its peak on February 20 to its low on March 18, while the S&P 500 dropped -29% during that same period. Off of these lows the markets staged a rally into quarter-end on the hope that fiscal stimulus might lessen the impact of COVID-19.
Figure 1: A view of the 2019 rise and 2020 year-to-date fall of S&P 500 Index performance.
Past performance does not guarantee future results.
Source: Impax Asset Management, Bloomberg.
Throughout March investors experienced violent swings with eight days when the S&P 500 Index was up or down more than 5% (4 up /4 down). Volatility as measured by the VIX spiked to 83 compared to its 30-year average of 19.1 The S&P 500 Index average daily performance change for March 2020 was 4.8% making it the most volatile month on record for the Index.2
In fixed income markets, interest rates dropped dramatically in a flight to quality as the 10-year U.S. Treasury fell to an historic low of 0.32% intraday on March 9. Spreads across the fixed income market widened significantly as credit concerns deepened, hammering the returns of investment grade and high yield bonds. Investment grade corporate spreads3 started the year at 100 basis points (bps) and widened to briefly touch 400 bps before closing the quarter at 300 basis points (bps) over Treasuries. Spreads on high yield bonds4 expanded from very tight levels of 360 bps at the end of 2019 to levels north of 1,000 bps — levels not seen since the Great Recession of 2008. The fixed income market also witnessed swings as rates bounced off historic lows with the 10-year U.S. Treasury rising to 1.20% before falling back to 0.64%.
Overshadowed by COVID-19 was what would have been the major story of any other period: Oil prices collapsed after Saudi Arabia induced a price war with Russia, further contributing to the fall in equities. The collapse in oil prices has also triggered concerns about a potential wave of bankruptcies in the Energy sector. Driven by this price war, as well as additional pressure on oil prices from plummeting demand due to the implications of COVID-19, Energy was the worst-performing sector in the S&P 500 Index for the quarter, dropping more than -50%.
Continued Economic Uncertainty
We expect that these whipsaw markets will continue for the foreseeable future. As we write from home at quarter end, uncertainty about the extent of COVID-19’s spread and the duration of various quarantine measures, is clearly negative for the economy and investor sentiment. The stark impact on human life continues to unfold in the U.S. and Europe, with new cases and lives lost every day. Until new cases begin to subside, uncertainty about the timing of a recovery will persist.
U.S. monetary and fiscal measures designed to lessen the economic impact of the virus are also unprecedented. With an estimated $1.5 trillion in Federal Reserve liquidity provision, combined with $2.2 trillion CARES Act stimulus package, monetary and fiscal measures are nearly 20% of U.S. gross domestic product (GDP). Combining these U.S. stimulus measures with global monetary and fiscal stimulus points to more than $9 trillion (11% of global GDP) directed at combating the global recession.5
While we hope these efforts can lessen the impact on the economy, economists and investors are still struggling to process the ultimate impact on economic growth, employment and earnings. Overall, while the risk of the worst case scenarios has been reduced, we are no doubt, in our view, facing a global recession that will likely deliver a fall in global GDP of between 1-5% for 2020, with the market seemingly pricing in a drop approximately in the middle of that range, followed by a reasonable recovery in 2021.
Navigating These Unprecedented Times
In our view, navigating markets during unprecedented times requires a well-structured investment discipline grounded in a number of measures: long-term focus; comprehensive risk evaluation; flexibility to consider a range of outcomes; and the ability to identify opportunities amid market volatility.
Our investment philosophy orients investments toward a transition to a more sustainable future, which is very much a long-term focus. This means that we look at issues that others may ignore, helping us build more resilient investment portfolios. We firmly believe that incorporating management of environmental, social and governance (ESG) risks within our fundamental research, along with a focus on quality companies, has helped many of our funds weather market volatility during this extraordinary time.
With so much uncertainty, we try to understand the range of economic outcomes. Looking at best, base and worst-case scenarios has helped us set ranges to manage the asset allocation in the Pax Sustainable Allocation Fund in a risk-controlled manner. We are similarly considering the range of economic outcomes to help assess the scope of potential COVID-19 impact on company fundamentals.
Market volatility can also provide an opportunity to rotate into high-quality securities at appealing valuation levels. Our focus remains on building diversified, appropriately positioned and resilient portfolios. Along the same lines, dislocation in the fixed income markets has caused spreads to widen considerably, providing an opportunity to add to positions in high quality, high conviction issuers on the margin.
Committed to Sustainability Efforts
The COVID-19 crisis and the abrupt shift from a bull to bear market does not deter our commitment to sustainability issues. It galvanizes that commitment.
As sustainable investors, engagement is a tool to advocate for corporate cultures that enhance long-term viability by being attentive to all stakeholders. We were very pleased to be a signatory to the Investor Statement on Coronavirus Response, along with 195 long-term institutional investors representing more than $4.7 trillion in assets under management. The statement urges companies to take steps to protect the welfare of their stakeholders, including employees, suppliers and customers during the coronavirus pandemic. It asks companies to provide paid leave, prioritize health and safety, and maintain employment and supplier relationships.
Especially during times like these, all stakeholders in organizations need to know that the services and people they depend on are there for them. We have instituted our own measures to help our employees and clients through the crisis with the minimum possible disruption.
You may be interested in reading some of our newest articles about sustainability issues related to the COVID-19 crisis, including one that explores how some companies are prioritizing stakeholders (while others, not so much) and one that discusses how to apply what we’ve learned from COVID-19 to the climate change crisis. We’ll continue to monitor developments and share insights on our website about the investment and sustainability implications related to COVID-19.
1 Source: David Kostin, Goldman Sachs
2 Source: Bespoke Investment Group, April 1, 2020.
3 Investment grade bond spread data represented by option-adjusted spread (OAS) of the ICE BofA US Corporate Index
4 High yield bond spread data represented by option-adjusted spread (OAS) of the ICE BofA US High Yield Index
5 Source: Cornerstone Macro.
The S&P 500 Stock Index is an unmanaged index of large capitalization common stocks.
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
The Volatility Index (VIX), is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments.
The 10 year treasury is a debt obligation issued by the United States Treasury Department with a 10 year maturity. It is the most popular type of US Treasury debt and is often used as a barometer for the overall U.S. economy.
ICE BofAML US Corporate Index is an unmanaged index comprised of U.S. dollar denominated investment grade, fixed rate corporate debt securities publicly issued in the U.S. domestic market with at least one year remaining term to final maturity and at least $250 million outstanding. It is not possible to invest directly in an unmanaged index.
The ICE BofAML U.S. High Yield Index is a market-capitalization-weighted index of domestic and Yankee high-yield bonds. The index tracks the performance of high-yield securities traded in the U.S. bond market. You cannot invest directly in an index.
One cannot invest directly in an index.
The statements and opinions expressed in media mentions are of the authors and as of the date of publication. All performance data quoted in media mentions represent past performance, which does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. See Pax World Funds’ performance for most recent month-end performance information. Holdings for the funds are subject to change. Please see the Pax World Funds’ holdings for current holdings information.