Note: This recap is a little longer than others, but we felt it necessary, given the market environment. We do not comment much on the Coronavirus. If you would like to read our take on Coronavirus, click here. If you would like to speak with us or have us review your portfolio, please email eric@accretivewealthpartners.com or steve@accretivewealthpartners.com.
February was a month to forget for equity investors. While things started out well for equity markets, they took a dramatic turn late in the month as the Coronavirus set off something that could best be described as a slow-motion panic. Major equity indices experienced drawdowns greater than 10%, and there were several days that featured 3%+ moves to the downside, while government bonds rallied.
The market for risky borrowers held up reasonably well, with the high yield index declining 1.41%. Much of that decline was due to the energy issuers, which saw their bonds sell off as the price of oil fell sharply into the mid $40s. That non-energy issuers held up so well is encouraging to us, as it means the credit markets were not sending the same signal as stock markets. Bond investors have a reputation for being smarter than stock market investors, so when the credit markets and stock markets send mixed signals, we are inclined to believe the credit markets.
After the initial shock of the Coronavirus, the market selloff seemed to be rather indiscriminate and somewhat mechanical in nature. This opinion/observation requires a brief explanation. There are significant assets that are managed to maintain a target level of volatility in a portfolio, usually 10-12%. These portfolios typically own a combination of stocks and bonds. When volatility is trending lower, these strategies tend to load up on equities. When volatility spikes in equities, like we saw in the last several trading days of February, these strategies sell stocks to get the expected volatility back to target. This behavior in and of itself creates more downward pressure on stocks and higher volatility, leading to more selling and even higher volatility.
The recent environment saw the VIX, a popular volatility gauge known as the “Fear Index”, rise from the low teens to the mid 20’s to over 40 (a nearly 200% rise). This can create a vicious feedback loop. A cousin of this strategy, called “Portfolio Insurance”, is believed to be largely responsible for the October 1987 crash. In case you were wondering, this is not an investment discipline that we subscribe to at Accretive.
February was a tough month in the market, there’s no question about that. The S&P 500 went from hitting an all time high on February 19th to a 7 day losing streak that resulted in a double-digit decline. That kind of environment has a way of changing things. As of this writing, the CME’s FedWatch Tool puts the likelihood of a 0.50% rate cut in March at 100%. This is up from a 0% chance of a 0.50% cut, a ~20% chance of a 0.25% cut, and a ~80% chance of no cut just one week ago. (UPDATE: On March 3rd, at 10am, the Fed surprised the market with a 0.50% cut to the target rate). Monetary support is no cure for a pandemic, but the effects of lower rates will likely be felt for longer than the effects of the Coronavirus. While commentators are quick to compare this to the 1918 flu, we wonder if the market effect will be more like the 1998 response to the Russian Ruble crisis.
At Accretive, we took the market activity in the back end of February in stride. When we build portfolios we do so contemplating both good markets and bad ones, with the goal to compound wealth over the cycle. The good news is that we have investments we hold for times like this and they behaved as we expected. The bad news is that it still does not make this kind of environment any fun to live through.
We tend to look for things to do in chaos, and we were happy to find a few things that we hope will benefit our client portfolios for the long term. We positioned our portfolios with the idea that we are in a “lower for longer” rate environment and found ourselves being a net buyer of equities. To that end, February featured an unusual amount of activity (for us) in our portfolios. If you have any questions on that activity, or would like us review your portfolio (with us or with someone else), we would welcome the conversation. Feel free to email or call any of us to schedule an appointment.
Email the Author: gary@accretivewealthpartners.com
