The performance of capital assets in 2020 Q2 is a result of the actions taken in the aftermath of the Covid-19 outbreak that started in Q1. In early April the Fed announced unprecedented monetary policy and lending activities to complement the $2.2 trillion fiscal Cares Act to help protect the economy from the consequences of the coronavirus. From that point, the capital markets applauded the actions to guard against increased economic fallout and plodded to a semblance of a recovery; albeit, narrowly focused. The markets are now showing somewhat normal volatility driven by news on the path of Covid-19; both good and bad.
Despite some pockets of relative outperformance, the benefits of diversification failed to materialize again in Q2 just like in Q1. The largest capitalization U.S. equities, comprised of Microsoft, Apple, Alphabet, Facebook, and Amazon, have generated very strong positive returns during this period while the broader markets continue to show negative year-to-date returns. Just like in Q1, exposures in some asset classes held to cushion large drawdowns failed to perform; they either followed the market down or, worse, underperformed the markets.
The large returns for Q2 are partly due to the recovery from the dire state of Q1. Consequently, it is best to look at how performance moved from Q1 to Q2 and where performance stands today on a year-to-date basis for a better understanding; we still have a long way to go! The following table shows performance for Q1, Q2, and Year-to-Date (YTD).
On a year-to-date basis, the S&P 500 (IVV) fell -3.2%, but other broad equity markets fell more including small cap (SCHA) -13.06%, international developed markets (SCHF) -10.82%, and emerging markets (SCHE) -10.64%. High dividend equities (DVY, SCHD, SPHD) suffered, as well, with much worse performance due to concerns about dividend cuts. Likewise, REITs (SCHH) faltered due to the potential for cash flow and lease deficiencies with a decline of -22.56%. Some diversifying exposures bucked the trend, including momentum (MTUM) +5.08%, but those were the rare exceptions.
The bond markets continued to show strength, consistent with Fed support of investment grade and non-investment grade corporate bonds. Broad core bonds (SCHZ) were up +6.41% year-to-date, led by U.S. treasury exposures, and credit exposures recovered as investment grade corporate bonds (LQD) generated a +6.46% return. High yield bonds (HYG) recovered from a very weak Q1 return of -11.61% to show a YTD return -5.10%.
Like I said on April 9 (https://www.dattilioash.com/our-blog/2020/4/9/new-ball-game), the economy and capital markets may have been given a temporary reprieve, but we are still hostage to the emerging path of Covid-19 should it’s negative consequences exceed expectations:
No one can predict the length and depth of the coronavirus crisis, but these new huge Fed actions certainly have the potential to fill a critical role to keep businesses and municipal governments functioning and support the pricing of risky investment assets. Due to this, and pending any additional unforeseen events, it is difficult to see a larger drawdown of financial assets than we have seen thus far. With the lows of the markets potentially taken out, certain classes of U.S. risky assets are likely to exhibit normal volatility and can be now be held. Consequently, tactical positioning that sold U.S. risky assets can now be reversed over the near term.