Dear Clients & friends,
March concluded one of the worst quarters for the equity market in 70 years, with the S&P 500 losing -19.4% in Q1 (-12.5% in March alone). What made the current selloff unique from a historical perspective is the speed in which this decline occurred. For perspective, it took the S&P roughly 16 months to reach a bottom during the financial crisis in 2008-2009. As the COVID-19 crisis unfolded in February-March, it took the S&P 500 just 33 days to fall from the previous high on February 19th to the recent bottom on March 23rd – a startling 34% drawdown in just over a month. We have seen sudden market shocks before (9/11 and “Black Monday” in 1987 come to mind); however, in those historical shocks, markets did not sustain the elevated level of volatility that we are currently experiencing. In so many ways, this crisis is different and presents challenges that are unique.
A pending U.S. recession seems certain at this point. We expect the U.S. economy to decline in Q2 and Q3, meeting the technical definition of a recession with 2 consecutive quarters of contraction. We believe it is possible that the U.S. economy will return to growth in Q4 or Q1 of 2021, establishing a new sustained period of growth. However, the COVID crisis is still in the early stages in the U.S., as we have yet to “bend the curve.” Much remains to be seen on how we eventually contain the spread of the virus and how long the shutdown will continue.
We believe the depth and duration of the coming recession will depend on 3 things: 1) the duration of the shutdown – the longer it persists, the more difficult to restart economic activity; 2) the eventual impact on the credit market – causing corporate defaults and, perhaps, problems for certain countries to finance debt; and 3) the residual impact on the U.S. consumer – with consumer spending comprising roughly 70% of U.S. GDP. A significant disruption to the credit markets and/or consumer spending could continue to cause economic and market deterioration long after the virus has been contained.
The investment community is currently focused on the effectiveness of evolving government fiscal policy (spending tax dollars) and the speed at which the U.S. economy is deteriorating. The prevailing question is, “where is the bottom” for equities? The truth is no one really knows the bottom without the benefit of hindsight. Managing equity risk in the current volatile environment is difficult, but there are cues we can take from history to help guide our assessment of market conditions. History tells us that equity markets tend to bottom 4 – 6 months prior to the end of a recession, so it is not prudent to focus exclusively on economic data, which is a lagging indicator.
In our judgement, the pricing of risk (i.e. equities) provides the best insight into market conditions and the forming of an equity bottom. Typically, as the stock market bottoms, the volatility in equity market trading will start to establish a downward trend. Simply put, the positive and negative swings in the equity market with start to get smaller. Also, corporate bond credit spreads (the difference between corporate bond yields and Treasuries yields) will start to decline, signaling increasing confidence in business health. When we see these market conditions appear and begin to sustain these trends, history would say that the bottom is forming. Until that time, we continue to favor caution.
To reiterate our many email and conference call communications, our Investment Committee has been very active over the last several weeks responding to the market’s behavior as it assesses the economic impact of the broad business shutdown. As we have conveyed in the past, the market hates uncertainty, and we are clearly in an extremely uncertain situation, both regarding the social impact of coronavirus as well as its economic implications.
The result has been heightened volatility, in both the stock and bond markets. Given the continued uncertainty, we have deemed it appropriate to reduce equity risk and limit credit risk. In several steps we have trimmed equity holdings, replacing them primarily with short-term US Treasuries. In volatile times like this, there is generally a “flight to quality” and we believe it best to take advantage of the security offered by these investments.
During March, two of our Structured Notes matured, and as a result of their buffers, both have significantly outperformed their underlying indexes.
While being defensive, we continue to examine the data and look for an appropriate reentry point. It is our opinion that this will not be a single time or event, but rather a process of gradually reentering the market as we begin to see signs of a bottoming as described above. While we do not believe we are there yet, we have still found some attractive opportunities in the current environment. With the proceeds of one of the matured structured notes, we issued a new note based on the S&P 500 Index. It has a term of 54 weeks and a 15% downside buffer. If the market increases in value, it will earn two times the index return (e.g. index up 10%, note is up 20%) with a cap of 29%.
We will continue to follow the market closely and make adjustments as we see appropriate to best protect and enhance your portfolio value over the long run.
We appreciate that these are difficult times for everyone in terms of concerns about the health and well-being of our families, potential disruption of livelihood and the impact on financial assets. We will continue to bring all our resources to bear on the management of your portfolio and keep you well informed, in an effort to free you to focus on the other important concerns in your life. As always, we stand ready to speak with you at any times to review your personal situation and any concerns you may have.
Securities offered through APW Capital, Inc., Member FINRA/SIPC. 100 Enterprise Drive, Suite 504, Rockaway, NJ 07866 (800)637-3211.
This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third party sources and is believed to be reliable. This presentation may not be construed as investment advice and does not give investment recommendations.
The securities presented may not be representative of the current or future investments for Compass Ion clients.
Additional information, including advisory fees and expenses, is provided on Compass Ion’s Form ADV Part 2. As with any investment strategy, there is potential for profit as well as the possibility of loss. Compass Ion does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. The investment return and principal value of an investment will fluctuate so that an investor’s portfolio may be worth more or less than its original cost at any given time. The underlying holdings of any presented portfolio are not federally or FDIC-insured and are not deposits or obligations of, or guaranteed by, any financial institution. Past performance is not a guarantee of future results.