“Weathering the Storm Together”
It is shocking how our lives have changed so dramatically in the span of a few weeks. While these are unprecedented and challenging times, we are grateful that everyone at Morton Capital and their families are safe and healthy. We hope that you and your families are as well. Beyond our company, we are heartened to see the strong spirit of cooperation on display every day in our larger community: hospital personnel and medical professionals exhibiting courage and dedication; pharmaceutical firms rushing to develop a vaccine; industrial companies shifting their businesses to manufacture ventilators; and even a beer brewery helping to produce hand sanitizer and giving it away for free to first responders. We may be isolated in our homes, but we are all truly in this together. We feel confident that we will emerge from this pandemic a stronger firm and community.
“The Bull Market Hits the Illiquidity Wall”
In a 180-degree reversal from 2019, volatility spiked and risk assets fell sharply during the first quarter of 2020. The U.S. equity market drop of over 30% from its February peak was the fastest such decline on record. The S&P 500 Index either rose or fell at least 4% in eight consecutive trading sessions, the longest streak in history. Given the sharp stock rally in the last week of the quarter, the S&P 500’s 19.6% loss appeared somewhat tame, especially as compared to broader markets: U.S. smaller company and value stocks and developed and emerging international stocks all experienced meaningfully higher losses. While the negative demand shock affected most commodities, oil was especially hard hit as it collapsed over 65% to the low $20s per barrel. Gold was one bright spot, up close to 4.0% during the quarter after a strong year in 2019. The table below summarizes the first-quarter performance for selected indices versus 2019.
While stock markets and commodities experienced significant volatility, the more unexpected story was the corresponding carnage in bond markets. While U.S. government bonds were up modestly, other major categories of bonds experienced significant losses. The below chart looks at the decline in various bond categories in 2020 as compared to their maximum drawdown during the 2008 crisis as well as their recovery when the markets rebounded in 2009:
Certain types of bonds will undoubtedly face challenges if the current economic climate worsens. However, the sharp selloff in bonds was not only driven by concerns for the future, but also by a wave of forced selling that sucked up all the liquidity in the bond markets. Counterintuitively, higher-quality bonds actually took some of the largest hits since that is where desperate sellers rushed believing that they would have the most liquidity. At this stage, certain bond securities seem to be oversold, as they also were back in 2008. The above chart demonstrates that opportunistic and patient investors who saw this as an opportunity back then were ultimately rewarded with equity-like upside when conditions in bond markets stabilized in 2009. We believe that we are with the right managers to capitalize on these types of moves. We currently have meaningful allocations to bond funds that we categorize as “tactical fixed income,” meaning that the managers have broad mandates to move in and out of various bond market segments depending upon where they see opportunities. These managers are now in a position to take advantage of the current market disruption if they believe it presents an opportunity for the longer term.
“Redefining Money at Ludicrous Speed”
In the classic Star Wars spoof, Spaceballs, light speed is not fast enough for Rick Moranis’s evil Dark Helmet. He insists that his spaceship jump to ludicrous speed, causing them to overshoot and lose their quarry. Similarly, recent events feel like they have been played out at ludicrous speed, starting with the fastest 30% decline on record for stock markets, followed up with a comparably fast and drastic monetary and fiscal policy response.
Back in the 2008 financial crisis, various government programs were rolled out by the Federal Reserve (“Fed”) and federal government over many months. In the current environment, government programs to shore up the economy and markets have been launched at a rapid-fire pace. The Fed has announced what equates to unlimited quantitative easing (or “QE”), which is a program where it essentially prints money to provide liquidity to the system. It accomplishes this by buying various securities, ranging from treasuries to corporate bonds, which aims to keep interest rates low and stimulate economic activity. QE was a favorite tool of the Fed’s back in 2008 after it lowered interest rates to zero and ran out of traditional stimulus methods. The scope of this current QE, though, makes the QE from 2008 look like child’s play. The Fed’s balance sheet has already increased to over $5 trillion and is projected to double to over $10 trillion by the end of 2020. These types of numbers are inconceivable in their size. Back in March of 2009, the entire global stock market was valued at around $27 trillion total. Today, we are talking about the Fed, just one of many central banks globally, owning assets of over $10 trillion. These types of policy moves are doing more than just stimulating economies and markets; they are redefining money. Money has historically been thought of as a store of value, but that definition is totally incongruous with the way it is being used today as trillions of dollars (and other currencies around the globe) are created out of thin air to stem the current crisis. The point is not that stimulus is not necessary given the extremity of the current crisis, but rather that there will ultimately be a cost.
“Focus On What We Can Control”
While there are many things outside our control in the current environment, there is also much that we can control about our own situations and how we respond to upcoming events. The recent stock and bond market volatility created an excellent opportunity for investors to reexamine and reaffirm their risk profiles. It is natural for investors to think they can handle more risk when markets are going up with very little interruption, as they had for the past decade. But recent events are a better measure of how much volatility investors can handle. Did this latest turbulence keep you up at night or were you confident in your long-term plan? Did you have the urge to get out of risky asset classes or were you comfortable with how your portfolio was positioned? When it comes to risk tolerance, there are two essential components: how much risk you should take to meet your goals and how much risk you are willing to take. The first component is a function of more objective criteria like your time horizon, spending needs and other data that can be input into your financial plan. The second component is all about emotions, but in spite of that it is an equally important part of the equation. Even if your financial plan dictates that you can have a more aggressive portfolio, if emotionally you cannot handle big swings, then that positioning may not be appropriate for you. After all, the best portfolio for you is one you can stick with, in good times and in bad.
Another important situation within our control is whether we have sufficient liquidity or emergency funds to meet our short-term cash needs. Certain asset classes like stocks, or even riskier bonds, are technically liquid on a daily basis. But just because you can sell daily does not mean that it is a good idea. On a short-to intermediate-term basis, stocks in particular should not be thought of as a source of liquidity. Instead, investors should have sufficient liquidity outside of their portfolios to meet their needs and handle any smaller emergencies that may arise. This prevents forced selling at the wrong time.
Finally, we can control how we allocate our portfolios and whether we are positioned aggressively or defensively in any given environment. When risks are heightened, as at present, we believe it is time to be defensive. Rather than avoiding risk (e.g., going to cash), this means favoring asset classes that we feel have more attractive risk/return characteristics than those of traditional stocks and bonds. While alternative assets are not immune to current events, they are typically much less sensitive than those traditional assets. We are in touch with all of our various managers and are monitoring the impact of current events on their portfolios closely. We believe that we are with the right managers that have the right mindset to face these types of challenges. The first order of business is protecting what we have, but if things deteriorate further, there will undoubtedly be opportunities for the longterm as well. We will continue to look beyond short-term noise towards how we can best protect and grow our clients’ assets for the longterm.
Please do not hesitate to contact your Morton Capital wealth advisory team if you have any questions or would like to review your portfolio or financial plan in more detail. As always, we appreciate your continued confidence and trust.
Morton Capital Investment Team
This commentary is mailed quarterly to our clients and friends and is for information purposes only. This document should not be taken as a recommendation, offer or solicitation to buy or sell any individual security or asset class, and should not be considered investment advice. This memorandum expresses the views of the author and are subject to change without notice. All information contained herein is current only as of the earlier of the date hereof and the date on which it is delivered by Morton Capital (MC) to the intended recipient, or such other date indicated with respect to specific information. Certain information contained herein is based on or derived from information provided by independent third-party sources. The author believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information. Any performance information contained herein is for illustrative purposes only.
Certain private investment opportunities discussed herein may only be available to eligible clients and can only be made after careful review and completion of applicable offering documents. Private investments are speculative and involve a high degree of risk.
The indices referenced in this document are provided to allow for comparison to well-known and widely recognized asset classes and asset class categories. Q3 returns shown are from 06-28-2019 through 09-30-2019 and the year-to-date returns are from 12-31-2018 through 09-30-2019. Index returns shown do not reflect the deduction of any fees or expenses. The volatility of the benchmarks may be materially different from the performance of MC. In addition, MC’s recommendations may differ significantly from the securities that comprise the benchmarks. Indices are unmanaged, and an investment cannot be made directly in an index.
Past performance is not indicative of future results. All investments involve risk including the loss of principal. Details on MC’s advisory services, fees and investment strategies, including a summary of risks surrounding the strategies, can be found in our Form ADV Part 2A. A copy may be obtained at www.adviserinfo.sec.gov.