Q1 2020 Investor Letter
Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.
As I am working from home like most of the country, I have been taking daily walks through the empty streets of Brooklyn and cannot help but reflect on my experience during and after September 11th. I was there the day the towers were hit, my office was destroyed and the firm’s employees worked remotely for the better part of a year. The world seemed upside down as it does now. While the current circumstances are clearly different, the uncertainty, anxiety, and concern I felt for my family, clients, friends, and the country’s safety and economic future feel eerily similar. I also had a similar experience during the 2008-09 financial crisis. I remember thinking things would never be the same again. Eventually, with time and unprecedented coordination from the public and private sectors around the world, our lives resumed a normal cadence. The global economy and markets not only regained their footing, but also most went on to significantly surpass their previous highs over the ensuing years.
What are we doing?
I am not suggesting we hold on and ride out the storm or that the economic or market recovery from this crisis will be as swift as the previous two – quite the contrary. What is most important during these times of extreme market volatility and uncertainty, is that we hold firm to our investment process. The reality is no one knows where the stock, bond, or commodity markets are going, but we are prepared, and in control of how we are reacting to them.
I want to reiterate that this is exactly why we started Blue Square. The traditional diversified portfolio that most financial firms use to manage their client’s money is, in our opinion, not enough to preserve capital during significant market declines. We feel very strongly that our clients deserve better and aim to deliver on that promise using our systematic, rules-based approach that we apply to investment assets (stocks, bonds, commodities, etc). When assets are declining significantly we aim to reduce our exposure and put the money into cash & cash equivalents to preserve your capital. This also serves as dry powder, money that we can reinvest in the future, to take advantage when the markets eventually bottom and start to recover. By taking a measured approach to removing and reinvesting capital based on market conditions, we aim to preserve and grow your portfolio over time and take less risk along the way. It is a simple approach that has served us well in the past. We believe that it will continue to deliver productive risk adjusted returns, over full market cycles, now and in the future.
We believe this is why having a rules-based approach is so important. It helps us to avoid being swayed by emotions and provides a roadmap to follow during even the most difficult of times. As we saw, the first quarter had a swift and significant market decline followed by a quick recovery that still left global stocks, as defined by the MSCI All-Country World Index, down -21.37%1 for the quarter. What was equally troubling as the quarter progressed was the lack of liquidity in the bond markets. If the Federal Reserve had not stepped in and announced multiple programs to support the bond market, things could have been very different. As it was, bonds, as defined by the Barclays US Intermediate Aggregate Index, finished the quarter up 2.69%2. However, that does not nearly tell the full story of the damage caused in the bond markets as High Yield US Bonds for example, as defined by the Bloomberg Barclcays US High Yield Index, finished the quarter down -12.68%3.
Our models began to turn defensive in early March, causing us to raise cash and reduce exposure across all stock and some bond asset classes. As of the end of the first quarter, the asset allocations for our Growth and Balanced composites were as follows:
BSAM Growth Allocation as of 3/31/2020
BSAM Balanced Allocation as of 3/31/2020
What comes next?
Until we have a vaccine, or at least an effective therapy for the coronavirus, uncertainty is the new norm. We still do not know the full extent of the economic damage but it will be severe. While a select few industries and companies are thriving, there will be massive unemployment as well as a significant drop in corporate earnings and GDP. We do not know how long it will take for the government stimulus to get into the hands of consumers and businesses, or how much longer the economy will be on lock down. It will take some time for the economic and corporate fundamentals to find a bottom. However, since the market is merely a discounting mechanism of future events, it will most likely recover sooner than the overall economy. It is hard to imagine that the markets have fully digested all the bad news, especially as the shut down has now become universally pervasive through most sectors of the economy. However, this does not mean the equity markets cannot continue to rebound in the near term, and possibly retest resistance at the old support levels.
Something else to consider is that most of the economic stimulus to date has been focused on stabilizing Wall Street by attempting to maintain liquidity in the markets. However, the health pandemic and economic shutdown is primarily a Main Street problem. As such, additional funding will be needed to help stabilize households, businesses as well as state and local governments. This stimulus will lead to a significant increase in an already bloated federal deficit. As a result, we have initiated a position in gold which we see as a hedge against inflation and as an alternative safe haven asset in our Growth and Balanced Portfolios.
Will this ever end?
It is hard to imagine that we will ever get through this. I am continually questioned by clients who wonder if protective masks and social distancing are the new norm? Will the economy and stock market be depressed for an extended period of time?
As a country, we are doing what is necessary to combat the virus and well on our way to finding a solution. While no one knows how long this will last or take to repair the damage it has caused, I am confident we will get through this. The uncertainty, anxiety, and concern will ultimately pass. Inevitably, challenging times create investment opportunities that we want to be in a position to take advantage of. The stock, bond, and commodity markets will eventually bottom and recover and our conservative, rules-based approach will help us navigate this storm.
Having said that, many financial firms will, in our opinion, not be properly positioned for what lies ahead. Please feel free to share this market commentary with those you believe would benefit from it, and know we will do our best to be available to assist anyone you refer to us.
We know and respect the enormous amount of trust and faith you have placed in us. I assure you we are more than up to the task. Please feel free to reach out at any time – we are all here for you and eager to assist however we can.
Stay healthy and safe,
& Chief Investment Officer
1) Source: Morningstar, MSCI All Country World Index NR 1/1/2020 – 3/31/2020
2) Source: Morningstar, Bloomberg Barclays US Aggregate 5-7 Yr Bond Index TR 1/1/2020 – 3/31/2020
3) Source: Morningstar, Bloomberg Barclays US Corporate High Yield TR 1/1/2020 – 3/31/2020
All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.