The first quarter of 2020 has been an unprecedented period in U.S. financial market history across numerous dimensions. We just witnessed the fastest 30% decline from a recent high on record for the S&P 500 (in only 30 days). Equities experienced historic volatility while U.S. Treasury yields recently dropped to all-time lows.
As we share details regarding the performance of equities in the prior quarter, investors should focus on a few points which we believe will provide perspective as we navigate through the next several months. Markets are forward looking, attempting to price the value of future cash flows. When reading negative headlines or news stories, keep in mind there is a distinct possibility this information has been priced into the market. When stock prices—or any asset’s prices—drop, forward-looking returns rise. OJM’s balanced portfolios were underweight U.S. stocks entering 2020 as a result of concerns related to the valuation of stock prices. Our outlook for U.S. stock returns has improved with their cheaper valuations.
Large-cap U.S. stocks fell 20% this quarter, having rebounded a bit from their historic drop. Small-cap U.S. stocks declined 31%. Developed international stocks and emerging-market stocks both dropped around 24%. Modest outperformance by U.S. stocks relative foreign counterparts has been due to the appreciation of the U.S. dollar, which has risen roughly 2.5% year to date.
Volatility, as measured by the VIX, reached its all-time high on March 16. Oil’s 25% drop on March 9 was its biggest one-day drop since the 1991 Gulf War. Finally, 10-year and 30-year Treasury bond yields fell to all-time lows of 0.54% and 0.99%, respectively.
In the fixed-income markets, core bonds gained just over 3%, once again playing their key role as portfolio ballast against sharp, shorter-term stock market declines. Bond yields have been extremely volatile. The 10-year Treasury yield ended the quarter at 0.70%, down from 1.92% at year-end.
Over the last six months, we have communicated our plan to reduce risk in the fixed income portion of our balanced models. The defensive slant added significant value to our balanced portfolios, reducing exposure to credit markets where floating-rate loans and high-yield bonds dropped around 13%. Investment-grade corporate bonds experienced modest losses of 4%.
Our allocations to lower-risk fixed-income and diversified alternative strategies have mitigated some of the equity losses. Treasuries, managed futures, municipal bonds and core bonds were top portfolio performers.
When you diversify across asset classes and consider a variety of potential scenarios, there will always be leaders and laggards in your portfolio. Some positions, like U.S. stocks, work well in strong up environments like we experienced last decade, while we have incorporated others that benefit portfolios during tougher times like Q4 of 2018 and Q1 of 2020. Diversity builds resiliency and protects a portfolio from betting on a single outcome, which can be a disastrous financial result if the opposite happens.
Our portfolio allocations to core fixed-income and alternative strategies performed well as stock markets sold off, delivering strong absolute returns and significantly outperforming U.S. stocks. These allocations helped to offset some of the decline in stocks and should continue to do so if the selloff continues.
Following the U.S. stock market’s 23% decline in mid-March, we added a modest amount back to our U.S. stock exposure. We continue to assess the point at which we’d further increase our exposure to U.S. stocks. If there are additional market declines and valuations become even more attractive, we plan to increase our equity allocation to an overweight to U.S. stocks.
During these historic times, it is paramount to stay disciplined and recognize when emotion rears its head in investment decision making. Investing based on emotion, is likely to result in exiting the market after it has already dropped meaningfully, locking in losses. Once discomfort and worry are gone, the market will already have bounced well off its lows.
Global markets have endured severe challenges and economic downturns in the past and have always weathered the storm. Attempting to time the market’s tops and bottoms is unrealistic; however, incrementally adjusting portfolio allocations in response to changes in asset class valuations, expected returns, and risks can be highly rewarding to long-term investors.
The time to be adding to stocks and other long-term growth assets is when prices are low and markets—and most of us personally—are gripped by fear and uncertainty rather than complacency, optimism, or greed. March of 2020 gave us the impression the market could continue dropping with no bottom in sight. Periods of uncertainty are exactly when research, analysis, patience, experience, and having a disciplined investment process come most into play.
The precipitating event for the recent volatility is something none of us have experienced before: a global pandemic and an extreme societal response. Our short-term future is uncertain; however, our investment playbook remains the same: diversify; balance long-term returns with short-term risks; buy low into fear, sell high into greed. We will remain disciplined in our approach to investing, will stay committed to our process, and will not allow emotion to influence our decision making. Please do not hesitate to contact us with your questions.
-OJM Group Investment Team