After a surprisingly strong year for stocks in 2019, the new decade got off to a rough start for investors with one of the most abrupt and rapid stock market declines on record. In just 5 weeks, the S&P 500 declined by more than 33%. Overall, U.S. stocks ended the quarter down about 20%, while the global stock markets declined by about 21%.
In previous communications, we focused on the broader issues of why the market was declining and what the decline meant to you and your financial plan. In this article, we will take a deeper look into how various sub-asset classes performed during the first quarter.
- High quality fixed income investments performed well during the quarter, with the Barclays US Aggregate Bond Index producing a positive return of +3.15%. As we would hope, the high quality fixed income provided a diversification benefit exactly when it was needed. Low quality fixed income, on the other hand, performed poorly, with the Barclays US High Yield Corporate Bond Index declining in value by -12.68%. Q1 demonstrated why high yield bonds are not a safe haven: when stocks go down sharply, high yield bonds decline in tandem.
- REITS were particularly hard hit during the market crash, with the Dow Jones US Select REIT Index declining by -28.5%. This is not surprising given the fact that many office buildings and shopping centers are currently underutilized or entirely empty. While REITs play an important role in a diversified portfolio, Q1 demonstrated why REITs are not a substitute for bonds. REITs, despite their high level of current income, can be as volatile as stocks and should be treated as such.
- In Q1, small company stocks as measured by the Russell 2000 index, posted a decline of more than 30%. The pandemic provided a vivid illustration as to why small company stocks are riskier than large company stocks. Small companies are not as well equipped as larger companies to handle the economic shocks of the magnitude we are experiencing, and that fact showed up in the Q1 stock market returns.
- Value stocks have historically provided investors with a premium relative to growth stocks, but not over the last few years. In Q1, this underperformance widened, with US large-company value stocks returning -26% (Russell 1000 Value Index) and small company value stocks posting a decline of -35.66% (Russell 2000 Value Index).
So, What Can We Expect Going Forward?
- Stocks have bounced back somewhat since the end of last quarter, at least as of today (4/15/2020). But we urge clients to remain vigilant, and always remember that unexpected bad news related to the pandemic (or some other unknown) could send stocks lower. No one knows the future. Our only realistic option is to stay diversified and stick to the plan.
- We think that investors, who are willing to invest and stay invested in stocks amidst the coronavirus uncertainty, can reasonably expect above-average returns going forward. However, earning these returns may require some patience and fortitude.
- Value stocks, both in the US and abroad, were historically “cheap” before this event, and now, they look extremely inexpensive according to certain measures. We think a value comeback is still in the cards, and we remain committed to the strategy of modestly overweighting the portfolios toward both small and value. But again, patience and discipline may be required.
Successful investors are optimistic about the future but are always prepared for short-term setbacks. That mindset is especially valuable in today’s environment, and we hope it provides some peace of mind that we plan for market downturns before they happen.
We remain committed to our investment philosophy and are confident that our approach, coupled with flexibility, ongoing risk management, and diligence will provide the highest likelihood of keeping you on track to reach your long-term goals.