The Q1 Crisis

The coronavirus took center stage at the end of February and blossomed into a full-blown health and financial crisis.  It is a foregone conclusion that there will be a worldwide contraction in economic activity of huge proportions that will negatively impact capital markets.  No one knows the depth and length of this crisis, but we are all hoping for a quick resolution.

During Q1 the benefits of diversification failed to materialize.  Exposures in asset classes held to cushion large drawdowns failed to perform; they either followed the market down, or worse, underperformed the markets.

The S&P 500 (IVV) fell -19.6%, but other broad equity markets fell more including small cap (SCHA) -31.6%, international developed markets (SCHF) -23.2%, and emerging markets (SCHE) -24.4%.  High dividend equities (DVY, SCHD, SPHD) suffered, as well, with worse performance due to concerns about dividend cuts.  Some diversifying exposures bucked the trend, including low volatility (USMV) -17.2% and momentum (MTUM) -14.8%, but those were the rare exceptions.

The bond markets were dominated by an extreme flight to quality with broad core bonds (SCHZ) up +2.0%, led by U.S. treasury exposures, but credit exposures were severely impacted with even investment grade corporate bonds (LQD) suffering with a -3.0% return and high yield bonds (HYG) returning -11.6%.

I took extreme action to raise cash (and other safe assets) in most client accounts, as I reported in my March 18, 2020 blog post, The 20% Solution, (https://www.dattilioash.com/our-blog/2020/3/18/the-20-solution):

It is a foregone conclusion that the economy will show significant weakness in the wake of this crisis.  Most of the factors that “tactical asset allocators” use to signal a “risk-off” environment are certainly signaling risk-off; either now or when the statistics are calculated and reported.

For this reason, I have taken most all of our client accounts to a 20% cash and U.S. Treasury position to help smooth the volatility.  For now, I have sold the riskiest asset classes including real estate investment trusts, international developed equities and emerging market equities with the expectation that they would suffer the most in a protracted situation.  I may do more selling depending upon how the situation evolves. I expect to reinvest the proceeds once the negative factors begin to turn positive.

No one can predict the future, but taking a position like this telegraphs my outlook that more downside risk is present.