February 2020

Market Condition: The market is in a correction. The general indexes and leading stocks experienced massive blows in the last week in February. Panic over the spread of the Corona Virus and uncertainty in US presidential elections weighed on markets. 

-In seven trading sessions the S&P 500 corrected 15.8%, the Nasdaq Composite fell 12.9% and the Dow Jones Industrial index dropped 16%. The drop is not that unusual, but the speed of the decline is. 

-U.S. economic data remains solid thus far, however, we have not seen the possible economic damage reflected yet. But the positive is that the impact of the corona virus is not likely to be a long-term economic risk. 

-The U.S. economy continues to exhibit strong underlying fundamentals, thus the probabilities of a recession or prolonged bear market are small, but can occur.

February started with a powerful recovery in equity markets following some initial fears of the coronavirus in late January. New all-time highs were achieved in the middle of the month. However, markets were focused once again on concerns of a global pandemic the last week of February as equities dropped dramatically and volatility soared.

The Dow Jones Industrial Average declined over 1000 points on Monday, February 24th. At the time, it was the sharpest one-day decline in more than two years. Declines continued to mount and worsen throughout the week. By week’s end, the major U.S. equity indices were all down over 10% from their highs, sending the Dow Jones Industrial Average, the S&P 500 and the NASDAQ Composite into official stock market correction territory.

Volatility, which had been largely dormant in recent months, spiked and the VIX Index rose above 40 for the first time since the “Flash Crash” in August 2015. We had expected volatility to pick up in 2020 and that materialized dramatically as the virus concerns spread more widely, but volatility and fear reached extremes as the month ended.

A flight to quality drove U.S. Treasury yields to historic lows. The 10-year U.S. Treasury yield dropped to 1.13% to close out February, and the yield on the 30-year U.S. Treasury fell to 1.65% by month’s end.

Despite ongoing concerns of the likely spread of the coronavirus, economic fundamentals continue to look solid and we would not change long-term strategic asset allocations at this time due to the virus.

Equity Markets

The final week of February turned out to be the worst week for equities since November 2008, which was at the height of the credit crisis. The week included a drop of -4.42% for the S&P 500 Index on Thursday, February 27th, which was the worst daily decline since August 2011 and the 106th worst day on record for this index going back to 1926. The selling pressure reached extremes and the market moved into oversold territory as the month ended.

Highlighting these oversold conditions, as well as expected potential action by the Fed, the S&P 500 rebounded by 4.6% on the first trading day of March. Although a lot of uncertainties still exist with the coronavirus, we believe the economy is in a much stronger fundamental position in 2020 compared to 2008.

We had anticipated a more volatile ride moving into 2020 due in part to valuations getting stretched after the year-end run in 2019, optimism reaching extreme levels (which can be a bearish indicator of complacency in the market), and normal election year volatility that markets historically experience in the first half of a presidential election year. We had even believed that a 5%-10% correction could materialize in the first part of 2020.

Clearly, we did not anticipate a global virus scare, but that turned out to be the trigger that moved stocks lower. Reflecting this heightened market volatility, the VIX Index, a measure of equity market volatility, spiked above 40 after spending most of 2019 and early 2020 below 15, with only a few moves above 20 during that time. The last time the VIX Index was at 40 was during the “Flash Crash” episode in August 2015 and following that point, the S&P 500 Index was up 9.6% over the next two months. Now, extreme optimism has turned into extreme pessimism and valuations have declined.

We acknowledge that there could be some material impact due to the virus on the global economy and the impact on corporate earnings could also turn out to be meaningful, especially in those sectors directly impacted by global trade and travel. At this point, trying to determine growth or earnings estimates is difficult. Volatility will likely remain elevated as the virus news continues to be a central focus of the market – the impact of which leads to uncertainty regarding near-term economic growth and corporate earnings. Based on historical impacts of prior epidemics/pandemics, we still consider this a shorter-term event and we believe the key to achieving long-term investor success is to not react to these types of short-term situations.

A meaningful difference between value and growth stocks. U.S. large-cap growth stocks still performed better on a relative basis compared to most other parts of the U.S. equity market and emerging markets performed modestly better than developed international markets in relative terms.

The numbers for February were as follows: The S&P 500 was down -8.23%, the Dow Jones Industrial Average was off -9.75%, the Russell 3000 declined -8.19%, the NASDAQ Composite slid by -6.27% and the Russell 2000 Index, a measure of small-cap companies, fell -8.42%. As mentioned, growth stocks outpaced value stocks on a relative basis rather dramatically for the month.

The large-cap and value focused Russell 1000 Value Index declined -9.68% compared to the Russell 1000 Growth Index, which fell by -6.81%. The value/growth difference held in the small-cap universe as well. Small-cap value stocks, as measured by the Russell 2000 Value Index, were off -9.72%, while the Russell 2000 Growth Index declined -7.22%.

International equities struggled as well in February. After strengthening rather steadily through January and the first half of February, the U.S. dollar slid lower over the final week and a half of the month. The dollar closed February only modestly changed from where it ended January. Emerging market equities, as measured by the MSCI Emerging Markets Index, fell -5.27% in February. The MSCI ACWI ex USA Index, a broad measure of international equities, declined -7.90% for the month.

Fixed Income

Outside of high-yield bonds, most sectors of fixed income enjoyed gains for the month with the backdrop of sharply declining interest rates. The flight-to-quality trade was the unquestioned winner late in February and U.S. Treasury yields hit historic lows as bond prices rallied, we already mentioned in our special report that we did take positions in Treasuries. The yield on the 10-year U.S. Treasury closed February 28th at 1.13% compared to the January close of 1.51% and a close on February 27th of 1.30%.

The yield on the 30-year U.S. Treasury fell to 1.65% at the end of February after it had closed January at 1.99%. The more interest-rate sensitive parts of the market were the leaders in fixed income in February. During the last week of February, Clark Capital’s Fixed Income Total Return strategy reallocated from 100% high-yield bonds to 50% high-yield bonds and 50% U.S. Treasures with the goal of protecting capital.

Economic Data and Outlook

Clearly the market was not focused on economic data over the final week of February as the coronavirus sell-off hit with full force. However, economic data covering January, which was released in February, was for the most part positive and continued to point to an economy that we believe will grow in 2020.

In a surprise, the widely followed Institute for Supply Management (ISM) manufacturing index broke back above 50 in January with a reading of 50.9. That was well ahead of expectations of 48.5 helped in part by the new orders subcomponent, which rose to 52 compared its revised prior mark of 47.6. The ISM non-manufacturing index, which covers the much larger service industries in the U.S. economy, also came in ahead of expectations at 55.5 when a reading of 55.1 was expected. Recall that ISM readings above 50 indicate expansion and both the manufacturing and service industries in the U.S. economy showed growth in January.

Job market numbers reported in February for January also easily surpassed expectations. Non-farm payroll additions were 225,000, which was well ahead of the anticipated 165,000 payroll gain. The unemployment rate ticked unexpectedly higher to 3.6% from the prior mark and expectations of 3.5%, but this was under the context of the labor force participation rate increasing as well.

This means more people moved into the labor force looking for jobs. The labor force participation rate rose to 63.4% from the prior level and expected reading of 63.2%. Average hourly earnings topped estimates as well increasing to 3.1% on a year-over-year basis in January when a 3.0% increase was expected. Furthermore, the prior month’s reading was revised higher to show a 3.0% gain compared to the prior estimate of a 2.9% increase.

The strong job market in the United States continues and, as a consumption driven economy, financially healthy and employed consumers are an important factor to economic growth. This continues to be one of the strong data points supporting our expectations of ongoing economic growth.

Retails sales growth (ex. auto and gas station sales) increased 0.4% in January, which was better than the expected 0.3% advance. Housing starts and building permits also easily exceeded expectations in January. Housing starts were at a 1.567 million annualized pace, while permits were at a 1.551 million annualized rate. Expectations were calling for readings of 1.428 million and 1.450 million, respectively. Existing home sales and new home sales were also better than expected.

The Leading Economic Indicators index from the Conference Board advanced at twice the anticipated rate in January with a 0.8% monthly gain compared to expectations of a 0.4% improvement. The second reading of fourth quarter 2019 GDP showed a 2.1% annualized growth rate, matching expectations and the preliminary reading.

After reviewing several of these economic data points, it is not too surprising that equity markets enjoyed positive momentum through the first part of February with the major equity indices putting in new all-time highs during the month. However, the coronavirus situation became the focus of the market and derailed equity market progress.

The Federal Reserve found itself once again as a central topic of the market (and President Trump’s tweets) late in February and investors were wondering if the Fed would take any action in light of the market sell-off. Expectations were building that the Fed might potentially take action before the next scheduled FOMC meeting on March 17th-18th and a 50-basis point rate cut was being priced into the market by that meeting. Indeed, on March 3rd, the Fed announced an emergency 50-basis point rate cut due to the potential economic risks posed by the coronavirus. This followed the conclusion of a meeting of G7 officials earlier in the morning where officials reaffirmed their commitment to be ready to act, but without announcing any concrete measures.

At this time, we maintain our expectation that the U.S. economy will grow in 2020. Clearly, how the virus outbreak spreads and impacts economic growth is yet to be seen and we are certainly not epidemiologists and don’t pretend to know how this virus situation will play out.

We will continue to assess economic growth and corporate earnings, but late month action in the markets showed that we were hitting some oversold levels. We still believe fundamentals will drive long-term results and at this point, the economy looks poised to continue to grow. However, volatility has picked up as uncertainly has moved into the market with the coronavirus, not to mention a presidential election that will only heat up in the months ahead.

For those of us who’ve endured numerous unsettling market times before, seeing others trade on fear is nothing new. We know as well as you do that the last two weeks haven’t been easy; after all, we invest in the same markets and strategies that you do. But risk is ever-present in the markets, whether it is always perceived as risk, or not.  

Our response is to remain disciplined, rational and calm. Historically, the market rewards those who stick with their long-term strategies and avoid emotion-driven portfolio moves. And, as we’ve said many times before: Fear is not an investment discipline. While volatility is never easy to stomach, we continue to believe that our tactical strategies are well-suited to help us navigate today’s markets.

If you would like us to review your current portfolio or discuss that old 401(k) account please email us at info@crosspointweath.com