An Unprecedented Time

It goes without saying that the first quarter of 2020 has been one of the most unprecedented and unusual periods in modern history. The impacts of the COVID‐19 pandemic have been widespread, swift and devastating. As of April 15, 2020, over 1.9 million people have been infected and over 127,000 have died, while the U.S. has seen the highest number of cases (over 600,000) and deaths (over 26,000) globally. To stop the spread of the virus, much of the world has been ordered to stay at home. After India issued a countrywide stay home order on March 24, the total number of people under such an order was over 2.5 billion, or more than the total world population alive during World War II. In the U.S., as of April 7, just over 300 million people (or 95% of population) were living under some form of lockdown.

Modern day science, information technology and statistical modeling have allowed for the

remarkable capability to track the pandemic nearly in real time, and to predict the intensity and path of the outbreak going forward. However, the lasting economic effects of the COVID‐19 pandemic are much more difficult to forecast. For one, past economic crashes have typically been due to financial excesses, as was the case in the Great Depression, the October 1987 market crash, the burst of the dotcom bubble and the Global Financial Crisis. In the current case, the blame cannot be cast on financial mismanagement—the pandemic has put the brakes on what was a relatively healthy global economic engine, causing shuttered businesses and massive job loss. In the U.S. alone, more than 17 million people filed for unemployment in the four weeks ending April 4, likely bringing the unemployment rate to nearly 15% (see Figure 1). As calls to “shelter in place” continue, JPMorgan Chase predicts that the unemployment rate will reach 20% by the end of June, and it could continue to climb. For context, peak unemployment in the U.S. during the Great Depression was 24.9%.

Figure 1: Weekly initial unemployment claims in 2020. Source: Fortune.

The current crisis will undoubtedly reshape the relationship between workers and the American economy, but it’s hard to know in what form. For example, a generation of Americans may become much less optimistic about their future—a loss of faith in the economy could lead to a period of deflation, or a loss of faith in the U.S. dollar could lead to inflation. We simply don’t know how the current widespread economic pain will play out, but it has likely already led to a global economic contraction deeper than any we have experienced in over 50 years. The International Monetary Fund (IMF) has forecasted that global GDP will shrink by 3% this year, a prediction that they acknowledge is made with “extreme uncertainty.” To contrast, during the last recession (the Global Financial Crisis of 2009), global GDP contracted by just 0.1% (see Figure 2). While the IMF does forecast a rebound in 2021, with the pandemic so profoundly altering the consumer‐based economy and with the development of a vaccine some ways away, it will likely be a slow recovery.

Figure 2: The IMF predicts that the world economy will experience the worst recession since the Great Depression. Source: IMF.

In the face of all these uncertainties, the U.S. Federal Government has responded with multiple monetary and fiscal measures. The Federal Reserve cut interest rates to near zero on March 15 after making a rare emergency rate‐cut just weeks before. The Fed also greatly expanded its bond‐buying program, making it unlimited and broadening the types of securities it would purchase, and announced emergency lending programs, including a Main Street lending initiative meant to serve businesses not covered by other government small business support programs. In March, the Fed’s balance sheet ticked sharply upwards, adding $1.6 trillion to a total of approximately $6 trillion. Meanwhile, Congress passed the $2.3 trillion dollar Coronavirus Aid, Relief, and Economic Security Act (CARES) which includes, among many other things, expanded and extended unemployment benefits, one‐time direct payments to most Americans, and various funds to support federal, state and local government relief programs. Congress continues to debate further stimulus as the impacts of U.S. shutdown ripple through all parts of the U.S. economy. Outside of the U.S., central bankers across the globe are taking similar unprecedented actions to prop up their hampered economies.

The market reaction. It’s hard to believe that just two months ago, market indices were at all‐time highs. The Dow Jones Industrial Average hit a record high on February 12. The S&P 500 hit its record high on February 19 reaching 3,386 after which it experienced the most rapid decline in its history, falling over 33% in approximately one month to 2,237 on March 23 (see Figure 3). In the first quarter of 2020, the S&P 500 returned ‐19.60%, though it, along with other U.S. stock indices fared better than foreign stocks. For example, the MSCI All Country World Index excluding U.S. stocks declined 23.36% while the full index fell 21.37%.

Figure 3: S&P 500 crashes, cumulative percent decline relative to peak. Source: The Economist.

The unprecedented nature of the contraction has led to another surprising outcome. Most bear markets are caused by financial factors in which unsustainable excesses (like overvaluation, or excess risk) suddenly implode, causing expensive assets to lose value while inexpensive assets gain (at least relatively). In the current market this pairing was turned on its head—value stocks continued to underperform growth stocks to a remarkable degree. The Russell 2000 Growth Index outperformed by the Russell 2000 Value Index by nearly 1000 basis points in the first quarter. Put another way, traditionally low‐beta stocks (generally considered lower risk) turned into high‐beta stocks at precisely the wrong time.

Figure 4: Value stocks declined significantly more than the broad market and growth stocks. Source: MSCI.

While the recent market performance has no doubt been singularly abnormal, it capped off what has actually been a quite unusual 12‐ month period. The trends outlined above (foreign stocks trailing U.S. stocks and value stocks lagging growth stocks) have been remarkably persistent over the past year. The underperformance of value versus growth stocks is particularly striking. As shown in Figure 4, for the one‐year period ending March 31, 2020, value stocks within the MSCI All Country World Index underperformed growth stocks by nearly 2000 basis points. This has left value stocks extremely discounted relative to the rest of the market—global value stocks are trading at just under 10x forward earnings compared to over 19x for global growth stocks and over 13x for the broader universe (see Figure 5). This means that the price of $1 of future earnings from value companies is almost half that of $1 of future earnings from growth companies.

Figure 5: As of March 31, 2020, value stocks are trading at a significant discount to growth stocks and to the broader market

By year‐end, many value‐oriented investment managers had tilted hard toward quality stocks at bargain prices, particularly foreign stocks. In our view, this sensible long‐term strategy was hit hard by the pandemic‐driven factors discussed above. The silver lining is that reasonable bargains have turned into extraordinary bargains in many cases, resulting in fertile buying opportunities for astute investors. We believe we are well positioned to take advantage of this dynamic going forward.

Update on the firm. As we’ve noted in previous communications, we have adapted to remote working, and our business operations continue uninterrupted. We remain in constant contact with each other through technology and are keeping our discipline around firm processes and procedures. Our diligence on existing and prospective managers continues as we look for long‐term opportunities in public and private markets. We all remain healthy and dedicated to our fiduciary duty to be good stewards of our clients’ assets.

We hope you remain safe and healthy during this unprecedented time. More than ever, we welcome your questions and conversation—please reach out to us anytime you’d like to chat.

Best Regards,

The Mangham Associates Team

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Indices

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