The past two months of April and May have been confounding in many ways. In the face of dramatically weak economic and corporate reports due to the corona virus, we would expect to see very weak capital markets, but the broad indices are showing only a modest year-to-date setback. Looking deeper into the story, however, we see much weaker underlying performance across many sub sectors of the capital markets.
The S&P 500 showed a recovery from its dire February and March performance of -8.1% and -12.9%, with respectable returns of +12.8% in April and +4.7% in May, respectively. Year-to-date (YTD) through May 29, the S&P 500 is down only -5%; a relatively modest decline given the economic disruption we have seen due to the COVID-19 outbreak. However, the S&P 500 is not the whole of the capital markets; some sectors are still well off their recent highs and still struggling to recover to former levels.
The following chart (of price performance) shows a sea of negative returns charted from the beginning of the year through the end of May. Major sectors like small cap (SCHA) and mid cap equities (SCHM) are much weaker with YTD total returns of -15% and -13%, respectively. Likewise, real estate investment trusts (REITs) have struggled with a total return of -23% (SCHH) due to the potential for disruptions in the earnings for income-generating real estate. Other income-generating asset groups like high dividend stocks follow that path with returns of -20% (DVY) and -8% (SCHD) due to prospects for dividend cuts. Alternatively, some equity asset groups did better like tech (VGT) with +7.0% and factor exposures like momentum (MTUM) +0.7%.
International markets were mostly weaker than U.S. markets. International developed markets (SCHF) were down -14% YTD and emerging market equities (SCHE) were down -16%.
Fixed income, on the other hand, performed much better with the classical “flight to quality” trade. Broad fixed income (SCHZ) produced a YTD total return of +4%, investment grade corporate bonds generated +4%, whereas high yield bonds were weaker at -4% due to the increased prospect of bond defaults.
So, once again, broad diversification proved to be hurtful, instead of helpful, to portfolio performance. As we know, situations like this often occur in the short term and realign to historical norms over time. We can expect this to be the story again, but the duration to recovery remains clouded due to the uncertainty surrounding the corona virus outbreak.