*This report is available in video format on your Orion portal.*
2020 Second Quarter Investment Market Report
This year, investors have been treated to a rare real-world lesson in the mathematics of investing—namely, the fact that after a market decline, it takes a greater market recovery to get back to even. The first quarter saw a frightening downturn that delivered 20% losses across the U.S. and developed foreign markets. Then we experienced a breathtaking 20% gain in the second quarter, the fourth-best quarterly rise since 1950. Work out the mathematics, and virtually all indices are still showing a loss for the year.
You can see this dynamic everywhere you look. The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—fell 20.70% in the first three months of the year, then gained 22.69% in the ensuing quarter. By the mathematics of the market, investors in the index are still down 2.88% so far this year.
International investors experienced the same lurching investment ride as U.S. stock holders, but with a shallower recovery. A broad-based index of companies in developed foreign economies lost 23.43% in the first quarter, then gained back 14.17% in the second quarter. Add it up, and the index is returning negative 12.59% so far this year. European stocks gained 14.33% in the second quarter, but because they were down 24.81% in the first part of the year, they’re still sitting on a 14.03% loss for the first half of the year. Asian stocks gained 10.82% in the second quarter, but for the year it’s in losing territory, down 9.29%. Emerging market stocks of less developed countries, gained 17.27% in the most recent quarter, making up some of the 23.87% losses in the first three months of the year. The index is down 10.73% for the year.
Our global equity fund, DFA Selectively Hedged Global Equity (DSHGX) accordingly finished down 2.87% for the quarter, and down 13.18% for the year.
Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index posted a 25.63% decline during the year’s first quarter, and then saw a nice 10.56% rebound in the second. Real estate investors are still down 17.77% for the year. DFA Global Real Estate (DFGEX), not an apples to apples comparison with the US index, finished the quarter down 13.34%, and is down 19.00% for the year.
The S&P GSCI index, which measures commodities returns, gained 27.37% in the second quarter, recovering some of the 42.34% 1st quarter loss. The index now posts a 25.39% loss for the year. Our commodity fund, DFA Commodity Strategy (DCMSX), again not an apples to apples comparison as DFA isn’t as concentrated on oil as the index, significantly under-preformed because of its underweight to oil, and finished down 9.36% for the quarter but has over-performed for the year being down 20.16%.
I am especially pleased with the performance of the equity-like portion of our model portfolios. Ironclad Managed Risk (IRONX), a strategy that sells put options on equity indices and exchange traded funds, was up 1.20%, and is down !.93% for the year. AQR Style Premia Alternative Fund (QSPIX), a strategy that invests long and short across six different asset groups: stocks of major developed markets, country indices, bond futures, interest rate futures, currencies and commodities based on four investment styles: value, momentum, carry, and defensive, was down 12.56%, and is down 16.32% for the year. Rounding out the mix of equity-like funds, LoCorr Managed Futures Strategy (LFMIX), formerly Steben Managed Futures Strategy, had a quarterly gain of 0.11% and is up 0.92% for the year. We have these funds in our portfolio to produce returns that are not influenced by the equity markets, so they are performing as expected and much of the reason our portfolios are doing so well, relative to those without equity like exposure.
In the bond markets, rates continue to drag on at historic lows. Coupon rates on 10-year Treasury bonds stand at an astonishing 0.68%, while 3-month, 6-month and 12-month bonds are still sporting coupon rates of 0%.
Our high quality bond funds, DFA Selectively Hedged Fixed Income (DFSHX), closed the quarter down 0.21%, and is up 0.42% for the year. DFA Global Core Plus Fixed Income (DGCFX) was down 1.23% and is up 1.46% for the year. Our Treasury Inflation Protected (TIPs) fund, DFA Inflation Protected Securities (DIPSX) was up 1.78%, a stunning 5.07% for the year, while our high yield bond fund, Vanguard High Yield Corporate (VWEHX), finished the quarter down 2.98%, and is down 3.67% for the year.
The market declined precipitously in March when people realized how much potential economic damage the COVID-19 virus, social distancing and the closing of many businesses could inflict on the U.S. economy. Then the market experienced one of the best quarters on record amid widespread optimism that some are calling euphoria.
Does that mean that the recent market gains represent a bubble? The evidence suggests that it does; the real question is how out-of-line stock prices are from reasonable norms. When you read about hairdressers day trading on Reddit, you know that at least some stocks are being bid up without too much concern about underlying valuations. But when you look at the Price/Earnings ratios going back to 1880, you see that the market today is still priced below previous peaks.
Does any of this mean that a severe market downturn is coming, or that stocks still have room to appreciate? That is a far more difficult question, for several reasons. First, does anybody know how well companies are managing to keep up their operations when their workers are doing their tasks at their kitchen tables? In other words, do we really know how much productivity and economic value is being lost during the pandemic? This is uncharted territory for businesses and companies alike, but you could make the case that public companies (we’re not talking about bars and restaurants) are just marginally less valuable now than they were at the start of the year, that the damage will be minimal and life will go on in the corporate world when everybody finally gets back in the office.. It’s also possible that they’ve suffered huge damage to their bottom lines and viability and current prices are unsustainable. You can have your opinions, but nobody really knows.
The other factor is the Federal Reserve Board, which appears to view itself as a fiscal backstop not only for the economy, but also for the markets. Try to imagine a hypothetical investor who has unlimited money in the bank, who decides that stocks are not going to go down and companies will have money in the bank even if they don’t earn it through operations. Would that investor ultimately have her way with stock prices? You have just imagined the reality that is the Fed. What we don’t know is how long and hard the Fed will fight to prevent a severe market downturn before, say, the November elections.
What are the facts on the ground? June hiring data showed a sharp reversal from May’s 2.7 million job losses. The ADP National Employment Report showed that more than 3.3 million workers were hired in the private sector in June. In addition, the most recent manufacturing indices were stronger than expected. But a total of 17 U.S. states have now paused their phased reopening programs due to the coronavirus, as the number of new daily cases rose 12.5%. Some hospitals in Texas, Florida, Arizona and California are reportedly reaching capacity. Then again, some news outlets report optimism that Pfizer–a component of the Dow Jones Industrial Averages and the S&P 500–had reported encouraging trial results of an experimental coronavirus vaccine, even though it’s unlikely that a vaccine will be available this year.
The conclusion of these analyses is always and forever the same: we honestly don’t know where the markets are going next, and we know with some certainty that trying to predict the market has, in the past, been a fool’s errand. The most prudent strategy seems to be to play defense without abandoning the potential upside of equities until we know how the pandemic and its economic consequences play out. That strategy would have underperformed in the past three months, and would have outperformed in the previous three.