Before reviewing last quarter's markets, we feel it is important to acknowledge all of the lives impacted by the current health and economic crises. The US will likely experience tens of thousands of deaths this month alone and there are officially 10 million newly-unemployed individuals (with at least an additional 5 million expected to be reported tomorrow morning). The impact of the COVID-19 pandemic in Q1 was staggering and that continues into Q2, although we hope the world is in a better place three months from now. Before looking ahead, lets look at the past quarter (and check out our Q1 market summary if you want to see all the numbers).
The most worrying dynamic that we saw in the financial markets was liquidity drying up in the fixed-income markets. The country was already preparing for a health crisis and an economic crisis, so a financial crisis would have been both terrible and compounded the first two crises. We expected riskier bonds to have problems and decline in price as the country started locking down, but when AAA-rated assets, federally-backed securities, and Treasuries began to sell off, we then recognized this was not just an economic problem. Many parts of the market were frozen and other parts were not functioning properly. Fortunately, the Federal Reserve was relatively quick to provide liquidity and the markets began to thaw and we expect that to continue. Prior to this crisis, we were about as defensive in fixed-income as we ever get. Looking ahead, we remain very pessimistic towards non-investment grade (and some investment-grade too) assets, but the prices for top-quality assets (that we expect will be "money good" even in a severe recession) are incredibly attractive.
Equity markets shrugged off COVID-19 news through mid-February, but began to selloff sharply as the health and economic situation deteriorated in late-February and March. Even though most lockdowns were not ordered until March, markets are generally leading indicators and began selling off on potential future risks. The decline in equity prices was incredibly fast (the fastest decline by some measures) and the benchmark S&P 500 had declined 35% from all-time highs in roughly a month's time. We do not have a crystal ball and believed it was possible for equities to move even lower, but we also had reasons to believe that equities would find a near-term bottom even in the face of worsening pandemic news. In addition to frozen credit markets (again an issue of liquidity, not economics), we saw many signs of retail investor capitulation and forced selling (which are typical of bottoms). Perhaps more importantly, even though the health situation was worsening it was nowhere near the worst-case scenarios that many had feared. By mid-March, many were projecting anywhere from a couple hundred thousand to a couple million COVID-19 deaths in the US. However, as the pandemic took hold here in the US, it quickly became clear that the higher estimates would not realized (and as of today, the high end of many projections is below 200,000 deaths). Thus, the best-case projections of a few weeks ago have become the worst-case projections of today. Of course, the projections can change, but the trajectory in the US is better than what we could have hoped for just a few weeks ago. Additionally, Congress and the White House passed multiple "phases" of fiscal relief and it appears that more is on the way. The dollar amounts and rollout have been lacking thusfar, but they did recognize the issues and passed legislation quickly (at least relative to 2008). As of today, the benchmark S&P 500 is up over 26% in the past two and half weeks.
The economic outlook remains uncertain. To a large extent, it depends on how we collectively behave to "flatten the curve" in order to successfully "re-open" the economy in stages. Of course, a lot of economic damage has already been done and additional fiscal relief is the only policy solution. While we encourage everyone to support individuals and small businesses during this time, the federal government is the only entity with the scale to support the financial needs of closed businesses and tens of millions of unemployed. We believe the economic situation will get worse before it gets better. Of course, the past quarter has illustrated that markets are not directly correlated with health or economic data, as markets express both future expectations and investor emotions. While we believed market prices were overly pessimistic a few weeks ago, they may become overly optimistic moving forward. We continue to monitor financial markets, economic realities, and investor expectations as we navigate the equity, fixed-income, real estate, and private markets.