Insights


Navigating Market Swings and Where We Go from Here

Despite the largest economic relief package in U.S. history, markets continue to grapple with the ongoing spread of the Coronavirus and its devastating impact on economic activity. Navigating the turbulence has been tricky for investors and managers alike. While news and market performance are constantly changing, the highlights from last week are below.

What’s Happening in the Bond Market?

Bond market liquidity (the ability to buy and sell large quantities of assets without disrupting the price) remains under pressure, as panicky investors continue to flee risky assets in search of high-quality safe-haven assets, such as U.S. Treasuries. This has led to significant spread-widening in corporate credits, as markets begin to anticipate rating downgrades and rising defaults amid the growing economic fallout from the fast-spreading Coronavirus.

When markets are under high levels of stress, the lower-rated segments of the bond market can behave similarly to stocks. This is because corporate bonds are tied to the financial health of the issuer. Companies with greater risk tend to have lower credit ratings and a higher likelihood of default (i.e., high-yield bonds) than those that are more highly rated (i.e., investment grade).

The chart below depicts how the various segments of the bond market have fared during the recent market downturn.

Source: Morningstar as of 03.27.2020
Indices: Cash: FTSE Treasury Bill 3-Month; Core Bonds: Bloomberg Barclays U.S. Aggregate Index; Investment Grade Credit: Bloomberg Barclays U.S. Credit Index; High Yield: ICE BofA U.S. High Yield; Emerging Markets: JPMorgan EMBI Global

Domestic Equity Markets Continue to See Huge Swings

Domestic equity markets experienced wild swings last week. Investors piled back into the battered U.S. equity market and the index climbed more than 20%, ending the shortest bear market on record, with the expectation that an unprecedented $2 trillion relief package might offset the pandemic’s impact on the economy. However, on Friday, as the United States surpassed China with cumulative confirmed cases of COVID-19, markets fell and halted the three-day rally. Despite Friday’s market drop, U.S. equities ended the week with gains of 9.2%.

Recent economic data is already showing the depth of this health crisis. Initial jobless claims spiked to more than 3 million, as large areas of the country remain virtually locked down to slow the spread of infection. Last week’s Unemployment Insurance weekly claims were five times higher than the previous record. In addition, a measure of U.S. consumer confidence fell the most since 2008 on Friday.

Last week, year-to-date basis selling in equity markets was broad-based. However, stocks in energy and financials were hardest hit in the sell-off. The information technology sector fared the best, followed by more defensive sectors such as utilities and consumer staples. Energy stock continues to come under pressure, as oil prices declined to multi-decades low. As a result of the price war between Russia and Saudi Arabia, the sector faces pressure from the supply side. Additionally, there is a significant drop in demand, with major economies remain on lock-down. The underperformance of energy stocks and financials contributes to the dominance of growth-style investing over value-style investing; Russell 1000 Value is down -27% year-to-date compared to -21% of S&P 500 performance and -16% of Russell 1000 Growth.

On the market cap basis, large-caps continue to outperform mid- and small-cap stocks. Large-cap stocks are more mature companies and tend to be less volatile during rough markets, as investors fly to quality and become more risk-averse.

Source: Federal Reserve Economic Data

No Respite in International Equities

Outside of the U.S., countries such as France, Italy, Germany, Spain and the United Kingdom have enforced a range of restrictions on commercial activity and social distancing. Eurozone growth forecasts will likely be as bleak as the U.S. Morgan Stanley expects GDP to fall 5% in 2020, with the most significant drop occurring in Q2 (32% on an annualized basis over the first quarter). Similar to the Fed, The European Central Bank (ECB) also fired a bazooka of asset purchases and programs to indicate a “whatever it takes” stance to support the economy and financial markets. The MSCI EAFE index, which is a proxy for international developed equity markets, is down -24% compared to -21% of S&P 500, since the start of 2020.

Year-to-date, emerging markets are down by -24%, with Latin America, specifically Brazil and Columbia, performing the worst. Asia has held up relatively better, and economic activity in China continues to recover but has not returned to normal. Chinese equity markets are down only -11% year-to-date with the market being led by many asset-light and internet-related companies. The performance of many of these businesses has been strong relative to other parts of the Chinese market, as Chinese citizens stayed home and downloaded a record number of games and apps on their smartphones.

How are Target Date Funds Performing?

Target date funds have not been immune to the recent market volatility. On a year-to-date basis, the returns on the 2020 series range from -1.3% to -15.3%, with the average manager returning -10.8%. The returns on target date funds in the 2055 series range from -9.4% to -24.9%, with the average manager delivering -21.4%.

The disparity in returns is not surprising, as target date fund managers with higher allocations in equities in their glide path tend to perform more poorly during stock market corrections. This reinforces the importance for plan sponsors to understand the risks when selecting a target date fund manager for their retirement plan.

Another interesting observation we have seen during the market downturn is that target date index funds are outperforming their actively managed counterparts. For example, through the close of business on Friday, the Fidelity Freedom Index 2020 series returned -10.7%, while the Fidelity Freedom 2020 series returned -12.8%. The return differences may be related to the short-term dislocations in the market, particularly within the higher-yielding fixed income allocation of their actively managed funds.

Where Do We Go from Here?

U.S. equity markets weathered Friday’s plunge to post their best weekly gains in over ten years, with the expectation of the unprecedented stimulus package which was signed into a law by President Trump late on Friday. The ultimate success of this stimulus package is yet to be determined, and likely impacted by factors such as new infection rates and successful policies to contain the virus. Due the uncertainty, plan participants may potentially continue to experience volatile returns. A long-term focus and a patient approach to staying invested is the key to riding out this market volatility. As demonstrated by this week’s market movements, the worst days in the markets are often followed by the best days in the markets. Missing out the best days could significantly damage long-term returns.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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