Morningstar Quarterly Market Commentary: Q1 Global Market Turmoil in 16 Charts
By Katherine Lynch and Tom Lauricella | 01 Apr 2020 (Morningstar)
For global financial markets–as well as just about everything else–the first quarter can be split almost exactly in half: before and after coronavirus.
The year began with financial markets weathering the threat of war between the United States and Iran, and by mid-February U.S. stocks were hitting fresh record highs, thanks in part to easier monetary policy. (For a summary version of this report, click here)
Then came the impact of the coronavirus, and the bottom fell out for stocks and credit-sensitive bond sectors. From its peak on Feb. 19 to its trough on March 20, the Morningstar U.S. Market Index fell 32.6% before rebounding from its lows in response to Congressional passage of a $2 trillion economic rescue package and aggressive steps to further ease monetary policy by the Federal Reserve. (Click images for better viewing)
For the S&P 500, it was the quickest bear market in history as the benchmark fell 20% from its peak in just 20 days. The S&P 500 lost 19.6% for the quarter.
It was not a straight shot down. Uncertainty about the virus made markets extremely volatile in March, and major indexes seesawed wildly throughout the month. There was only one day in the month where the S&P 500 didn’t move more than 1%.
All major equity indexes posted losses. Along with the worsening news of COVID-19, oil prices reached historic lows when Saudi Arabia initiated a price war with Russia. In turn, value stocks sunk further.
The Federal Reserve made two emergency rate cuts and implemented other aggressive moves to flood the financial system with liquidity and help ease strains on banks. Stocks rose after the first interest-rate cut on March 3, but after the second on the 15th, equities experienced their largest one-day drop since 1931 as investors confronted the economic reality of the COVID-19 landscape.
Amid the the uncertainty, high-yield bonds suffered the most as investors worried about the impact that the economic shutdown would have on low-quality borrowers. Government bonds and, to a lesser extent, core bonds strategies (which take on some corporate lending risk) did well as yields fell and investors sought out safe havens. Other defensive holdings such as gold and the Japanese yen rose in value, while most other commodities fell.
Global equities lost 24.0%. U.S. stocks fared slightly better with a loss of 20.6%. Emerging-markets and dividend-focus stocks offered no reprieve, losing 24.6 and 26.1%, respectively.
The technology, utilities, and healthcare sectors managed the best during the quarter. Energy stocks had their worst quarter on record, losing 51.9% in the course of three months.
After a quarter of very low volatility–there were only six days in the fourth quarter of 2019 when the S&P 500 gained or lost more than 1%–the first quarter of 2020 was the polar opposite.
While the fourth quarter didn’t have a single day with a return greater or less than 2%, there were 21 such days in the first quarter of 2020. At the same time, there were eight sessions where the S&P moved more than 5%.
The extreme volatility in the market is also evident when looking at standard deviations of major indexes. Standard deviation was a massive five times higher in the U.S. equity market for the first quarter than in the fourth quarter.
During the first two weeks of the sell-off, whether a stock landed in the growth or value bucket didn’t make much of a difference. Most were hit equally hard. But as the market volatility wore on, the long-standing trend of outperformance for growth stocks over value stocks re-emerged. As seen in the following chart, there was a greater correlation between where a stock landed in the growth-value spectrum than market capitalization.
For each of the value categories, the declines were the largest in the 23-year histories for the three Morningstar value indexes, eclipsing even 2008 global financial crisis losses.
Large growth stocks suffered the least and remain the only grouping of stocks in the black for the trailing one-year period.
As with style factors, the initial days of the sell-off saw indiscriminate selling with little distinction between sectors or quality among companies. But as the bear market wore on, some significant differences in performance materialized.
Energy stocks extended already large declines as oil prices collapsed thanks to a double whammy of the abrupt halt to economic activity and as the price war between OPEC and Russia fueled the global oversupply of oil. Financial stocks, meanwhile, posted steep declines as the Fed’s reduction of interest rates to zero hammered expectations for banks’ ability to generate interest income, and as the economic collapse raised worries about a jump in delinquent loans.
Technology stocks benefited from their relatively low exposure to the economic fallout from the virus, while utilities stocks found relative buoyancy as investors sought out the higher yields which resulted from share price declines. Healthcare stocks, despite the potential benefit of the crisis to some companies in the sector, still lost 12.8% amid the growing pandemic.
Meanwhile, higher-quality stocks managed the sell-off better than lower-quality firms, as reflected in Morningstar’s Moat Indexes. Wide-moat stocks have the strongest competitive advantage and no moats, the least. Essentially, the moat designations can be seen as a forward-looking definition of quality.
The Wide Moat Index lost 15.6%, beating the U.S. market by 5 percentage points, finishing the quarter well above the No Moat Index’s 29.5% decline. In addition to the relatively safety of companies with stronger competitive advantages, Morningstar Index’s Dan Lefkovitz noted sector weightings contributed to the outperformance of the Wide Moat Index, which has greater exposure to consumer defensive and telecom, and is underweight energy, basic materials, and real estate, where competitive advantages are rarer. Conversely, the No Moat Index is overweight energy, materials, and real estate and has a significant underweight to healthcare.
More broadly, foreign stock indexes were down across the globe. China, which had the greatest losses in January and February owing to the virus’ emergence in the country, recovered slightly by quarter-end. Brazil and the U.K. were the most battered among major markets.
A silver lining for investors with cash in their portfolios is that the massive market declines appear to have opened up wider opportunities for finding undervalued stocks. Based on fair value estimates from Morningstar’s equity analysts, two thirds of North American stocks ended the quarter undervalued.
The story in the bond market was one of a flight to safety. Bonds with credit risk–such as investment-grade and high-yield corporate bonds–were dragged down by worries about the economic impact of COVID-19, especially for borrowers with lower credit quality. That meant that many portions of the bond market were still in the red for the quarter, offering somewhat less diversification from the stock market decline than investors might have expected from their bond holdings.
Within the U.S. Treasury bond market, the combination of the Fed’s aggressive easing efforts and expectations for a massive drop in economic activity sent yields sharply lower across the board. Where the yield curve had been largely flat and at times inverted last year with long-term yields higher than short-term yields, the collapse of the economy–coupled with expectations of a rebound after the virus fades–left the yield curve in a steeply sloped pattern.
In the corporate bond markets, credit spreads widened massively. However, they did not reach the peak levels seen during the financial crisis when the corporate bond market effectively stopped functioning. The Fed’s efforts, coupled with the bailout package from Washington, also helped stop the bleeding in the credit markets before quarter end.
Currencies and Commodities
In the currency markets, trading was also volatile, dominated by an initial flight to safety that led to investors piling into the Japanese yen, which rose nearly 6% through March 9. The dollar and euro also benefited from that trend. However, as the global spread of the virus became clearer and the Fed and European Central Banks eased policy, those trends largely reversed course.
With its reputation as a store of value in times of crisis, investors piled into gold. Meanwhile, economically sensitive copper slid.
Oil prices experienced a historic plunge, collapsing to $20.5 per barrel from $61.10 at the start of the year. An investment of $10,000 in oil one year ago would leave you with only $3,325 as of March 31. The same investment in gold would have profited by $2,237.