- After an incredibly weak March, investors benefited from a sizable market rebound in April. Year-to-date returns broadly remain negative, with the exception of fixed income.
- For the first time ever, oil traded with a negative price amid a worsening supply/demand imbalance.
- Even though the general performance in financial markets was positive in April, lagged economic data is starting to reflect the negative economic impacts of COVID-19, and those grim headlines are likely to persist.
April Market Recap
Most investors would prefer what happened in March stays in March. It was an incredibly volatile and severe drawdown month. However, the markets rebounded and recovered some first quarter losses in April as investors were able to move past the initial panicked reaction to the COVID-19 pandemic.
It was certainly a welcome reprieve for investors as volatility fell, supporting liquidity and allowing for more normal trading activity. The CBOE Volatility Index (VIX), which measures the implied volatility in the U.S. equity market, dropped to an average of 41.5 in April and closed at 34.2, implying +/ – 2.2% daily moves in the S&P 500. For comparison purposes, in March, the VIX averaged 53.5, which translates to +/- 3.4% daily moves.
In terms of performance, most asset classes generated positive returns in April as the bid for risk assets came back. Within fixed income, U.S. interest rates across the curve were range bound and ended the month flat, while credit spreads tightened globally, most notably in riskier segments of the market. Core U.S. bonds gained 1.8% over the month for a year-to-date return of 5%. U.S. High Yield returned 4.5% in April but remains in negative territory for the year, down 8.8% since January.
Equity markets experienced the strongest recovery in April, particularly U.S. companies, with large and small cap indices up around 13%. Small caps took a severe hit in March and year-to-date returns remain deep in negative territory at -21.1%. Performance in real assets and alternatives was mixed, but the outlier was midstream energy, which generated an astounding 49.6% over the course of the month. Note that this return follows a very sharp first quarter drawdown of -57.2%, so the index remains 35.9% below its value at the start of the year.
It’s difficult to pinpoint one catalyst for the broad market rally; however, there were several key developments and themes that likely contributed to the risk-on sentiment.
First, it seems that as more time passes, the amount of uncertainty in terms of the potential health impact of the virus is waning, albeit at a slow pace. As countries and regions across the world begin to reopen and discussions about that process advance, those headlines and positive news flow likely spur some investor optimism.
Another crucial factor at play is the unprecedented stimulus that we’ve seen at a global level to date, on both the monetary and fiscal fronts.
From a fiscal standpoint, governments provided tremendous amounts of financial support to individuals, small business, and other organizations most severely hit by the shelter-in-place order.
On the monetary side, central banks cut interest rates and continue to ramp up asset purchase programs, which are expected to continue for the foreseeable future. In its most recent meeting, the Federal Reserve held rates unchanged but reiterated the commitment to support markets until significant progress is made with the economic recovery. The European Central Bank assumed a similar stance – current policy rates remain at the same low levels, but leaders stand ready to act as needed.
Oil Trades with a Negative Price
While the risk-on tone emerged in most markets, the oil market was one that did not participate in the rally and had a very challenging and volatile April.
At the beginning of March, Russia and Saudi Arabia were engaged in a standoff over oil prices, resulting in both countries increasing production at a time when demand was waning and financial markets broadly were under pressure.
In early April, the major players reached an agreement to cut production in the face of a severe drop in demand, but supply still overwhelmingly outpaced demand amid the virus outbreak. The supply/demand imbalance further exacerbated the pressure on oil markets, driving prices into negative territory for the first time in history.
While this is unprecedented, it’s conceptually straightforward. Oil is traded via futures contracts, and to put it simply, given the amount of excess supply, holders of those futures contracts didn’t need or weren’t able to receive delivery of the oil at expiration. As such, holders were willing to pay someone else to own the contract and take delivery of the oil. The price of oil has since rebounded into positive territory, but we expect more volatility and price pressure in the near future.
While most financial markets enjoyed a solid rebound in April, it’s important to note that now is when we should be prepared for economic headlines to become increasingly negative. Economic data, which is typically released on a lag, has already shown signs of deterioration in labor markets and business activity. On the jobs front, over 30 million Americans have filed for unemployment benefits in the last six weeks. Businesses are struggling too, with over half of the S&P 500 companies already reporting first quarter earnings through April that show average profit declines of -14%.
Analyst expectations for second quarter and third quarter earnings are even worse at -37% and -15%, respectively. At the macro level, the first estimate of first quarter GDP showed a 4.8% decline – the biggest drop since the financial crisis. For context, GDP plummeted 8.4% in the fourth quarter of 2008.
These dismal economic prints are likely to continue for weeks and months, but the key question is how and when the recovery starts to develop, which is largely centered on our ability to control the virus.
Since the end of the Global Financial Crisis, broadly speaking, volatility across assets classes had been relatively benign with the exception of a few short bouts. In periods like that, it can be challenging for active managers to find opportunities and generate meaningful alpha relative to passively managed indices. As the saying goes, a rising tide lifts all boats.
We find ourselves in a different position today amid the COVID-19 pandemic, which has already created significant amounts of volatility in financial assets and will likely have economic implications for years to come. It’s in markets like these that active managers must be dynamic and deliberate in their investment approach to consistently drive strong positive risk-adjusted performance for clients.
From an asset allocation perspective, we continue to refresh and evaluate our capital market assumptions and assess the implications for our clients’ portfolios. Unless you have any changes in objectives or cash needs, we advocate for maintaining the established strategic asset allocation that is rooted in fundamentals. Timing markets correctly is very challenging, especially in today’s environment. We encourage you to keep your investment horizon in focus and don’t let emotions influence portfolio positioning.
You can read more about asset class performance last month in our April Market Recap.