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First Quarter 2020 Review

In recent years, we have chosen to publish our market commentaries on a biannual, as opposed to quarterly basis. We felt such a timeline better aligned with the long-term perspective we take to investing and allowed us to provide you with more meaningful, unique insights, as opposed to reviewing what may (or may not) have driven short-term market swings in a given 90-day period. While we hope that this move has been helpful for you, we feel we would be remiss if we did not break from this pattern to address what has been a tumultuous start to the year and share with you our thinking about the situation at hand.

After an impressive performance by risk assets across the board in 2019, even the early days of this year were marked by volatility. Following a targeted U.S. strike which killed an Iranian general, tensions between Washington and Tehran rose dramatically, roiling equity markets for a brief period. Though the situation quickly de-escalated, it certainly served as a reminder that market risks can frequently manifest themselves quite rapidly and unexpectedly. As we mentioned around the time of the Soleimani affair, few market pundits, if any, considered instability in the Middle East a key risk going into 2020. Yet for a fleeting moment, it seemed to pose an immense threat to markets. However, as quickly as volatility spiked, it just as quickly dissipated, and markets continued their ascent even higher. The passage of “Phase 1” of the U.S.-China trade deal drove optimism that the ongoing economic conflict between the two nations was on the path to resolution, a move which many believed would stoke business confidence, and ultimately, shift the global economy into a higher gear. In the weeks after President Trump and Chinese Vice Premier Liu He signed the agreement in mid-January, equity markets appeared to be pricing in such an outcome, with the S&P 500 yet again setting new records.

Yet as all of this was occurring, some were beginning to take note of unsettling developments coming out of China. The spread of COVID-19 from its epicenter in Wuhan to other parts of the country at first led us to initially believe that much of the risk would be concentrated in the world’s second largest economy, which had already shown signs of flagging growth. However, our concerns, and those of investors around the world, quickly magnified in both scope and scale as time passed. Despite efforts by authorities around the world to contain the virus, it quickly spread to industrialized and emerging economies in an unpredictable fashion. As the month of March began, it soon became clear that this was rapidly becoming a public health crisis of global proportions.

Indeed, March was marked by the seemingly relentless spread of COVID-19, with the number of confirmed cases and resulting deaths increasing at an alarming rate. New containment measures were implemented in most countries, with “social distancing” efforts shutting down many workplaces, schools and shops, grounding most flights and leading to the cancellation of countless events scheduled for the coming months. Though these measures have generally been seen as prudent and necessary given the circumstances, they effectively brought economic activity to all but a standstill in much of the world. The implications of these policies on corporate and consumer spending have not been lost on global markets, with market volatility spiking dramatically. On average, the S&P 500 moved 5% a day in March, the most of any month on record. For comparison, during the depths of both the Great Depression and the Global Financial Crisis, average daily volatility in any given month never rose above 4%. In addition, March saw the S&P 500 fall over 30% from its record high set in February, in what was the fastest drop of this magnitude in history. With unprecedented moves in markets, and in the behavior of consumers, corporates and sovereigns alike, it was not difficult to see that tectonic shifts in the global economy were underway.

As the month of March drew to a close, markets around the world found themselves in the midst of what appeared to be a recovery rally, with the S&P 500 having its best week since 2009. The passage of a $2 trillion fiscal stimulus bill in the U.S., along with signs that the spread of COVID-19 was slowing in certain parts of the world, led many investors to believe that the recovery from this crisis would be a swift one. Though U.S. consumer sentiment hit a three-year low, and two consecutive weeks of record jobless claims saw nearly 10 million workers file for unemployment, this generally seemed of little concern to markets. Instead, euphoric sentiment has persisted, with many discussing the prospect of a “v-shaped” recovery. Though data shows parts of the U.S. most deeply impacted by the virus may be approaching a zenith in cases, new “hot spots” are potentially beginning to emerge. As such, authorities around the country have found themselves frequently left with no choice but to extend, and in some cases, expand social distancing measures. Despite some encouraging signs that these measures are beginning to work, we believe it remains far too early to assume we are firmly on the path to a quick recovery. Markets, in some ways, have reflected that, with dramatic daily moves both upwards and downwards still quite frequent, typically driven by whatever the 24-hour news cycle has offered up in the way of sentiment. While it is our hope that this situation will approach resolution sooner rather than later, we believe investors have failed to adequately consider the vast yet unavoidable toll this crisis is likely to ultimately have. Indeed, though volatility persists and markets remain well off their highs, we feel consensus may still remain too sanguine at the moment. As such, we are of the belief further downward pressure on asset prices is not out of the question, especially as investors reconcile lingering optimism (and in some cases, complacency) with economic reality.

Given this situation, we have and will continue to move deliberately as we work to allocate capital in what will likely continue to be a volatile market. We have been opportunistic in several instances, adding to positions where we feel prices have dramatically undershot long-term fair values, and have also initiated new positions in a couple of cases. For example, we added Berkshire Hathaway to our list of holdings towards the end of the quarter, taking advantage of a discount to book value that has only arisen during the most pronounced periods of market distress over the past few decades. It is our belief that Berkshire, with its legendary management team and $120 billion-plus war chest, will likely see its opportunity set for acquisitions, minority investments and financing deals widen in this environment, on terms far and away more favorable than a mere six months ago. As we took a closer look at the business, we came to find that even putting a fraction of Berkshire’s cash pile to work at a moderate rate of return versus history would likely result in significant value creation for shareholders, especially if the company returned to valuations in line with history. This made the decision to invest, after requisite diligence, a rather easy one for us, and we are prepared to add to the position should the discount to book value increase further.

While the investment in Berkshire Hathaway serves as an example of the kinds of opportunities environments like this can present, we feel it important to emphasize that despite what has transpired year-to-date, we do not feel as though markets have offered up a profusion of bargains just yet. As you likely recall, we have for quite some time bemoaned the dearth of opportunities to invest at compelling valuations. While this has gotten somewhat better, we think few would argue most assets, especially U.S. equities, have become dramatically cheap. Though we believe there are some companies which have seen their share prices unduly impacted by recent events, we feel many corners of the market, even now, remain quite fully priced. The situation is somewhat better in Europe, where valuations both as a whole and for specific companies have allowed us to take more pronounced action in our European Equity Strategy. In addition, we feel equities in emerging markets are beginning to look interesting and have allocated more effort searching for select opportunities there than we have in quite some time.

We have also dedicated a significant portion of time beginning to think about how best to position fixed income allocations for the balanced portfolios we manage. As we discussed earlier in the quarter, many of the typical “haven” assets that traditionally benefited from market volatility experienced losses during this rout, with an often-surprising lack of liquidity resulting in outsized swings in certain securities. Fixed income markets behaved in a particularly strange fashion, and as such, we opted to dramatically reduce our exposure to assets with longer duration or any credit risk, instead favoring short-dated, risk free assets. While we will likely maintain this positioning for the time being, it is our intention to return to a more traditional fixed income allocation once markets begin to act more rationally. With rates across the world having fallen in response to this crisis, generating an acceptable risk-adjusted rate of return will be harder than ever in the fixed income space. However, we believe dislocations in areas like corporate credit and emerging market sovereigns will create opportunities to find value, especially in less efficient corners of those markets. We have already begun to identify potential partners in these spaces, seeking managers who not only follow rigorous risk management and fundamental due diligence processes, but also have a strong track record navigating the entirety of the credit cycle. We believe allocations to such managers will not only complement our work on the equity side, but also strengthen the quality of our fixed income allocations as the cycle begins to turn.

Yet regardless of where our global search for value has taken us, we still find ourselves retaining a good deal of dry powder, especially when one considers the cash in our balanced portfolios that would typically be invested in fixed income securities. Though the rout in global markets year to date has certainly made things more interesting for us, now is certainly not the time to compromise our standards for capital allocation. Should volatility persist as we believe it might, the opportunity set before us may widen significantly. Our list of potential candidates seems to be widening by the day, and we are working hard to perform diligence in a thorough yet efficient fashion so as to be ready to act if and when markets present us with the right price for certain assets. While some initial steps have already been taken, we expect more activity into the second quarter and beyond.

Undoubtedly, this is a situation unlike anything any of us have experienced before, whether in markets, in global events, and quite frankly, in our lives. Each day sees a slew of new, and in some cases unfamiliar, information and data patterns to process, making what has been a strange and unsettling situation frequently more so. In our eyes, it is quite difficult to offer much in the way of a view on what the world may look like after this situation stabilizes, and frankly, as we have discussed in the past, we have little interest in making such prognostications. Instead, our focus will remain on seeking opportunities to allocate capital wherever they may exist and ensuring that client portfolios are positioned prudently. Should you have questions regarding your portfolio specifically or wish to further discuss areas where we see potential, we strongly encourage you to reach out. As always, we greatly appreciate your support and trust, and wish you and your loved ones health, safety and happiness in what are undoubtedly difficult times.


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