Investment Perspectives and OutlookS E C O N D Q U A R T E R 2 0 2 0

VIRAL IMPACT

2020 started out on a high note. In January and the first weeks ofFebruary market fundamentals were as positive as they had been inyears. Companies and consumers were upbeat and the job marketscontinued to improve. But by mid-February, market volatility hadspiked to levels on par with the financial crisis more than a decadeago, as a medical term, COVID-19, became a significant part of ourdaily lexicon amid a new pandemic in the making.

Shortly after hitting their peak in mid-February, markets saw anabrupt course reversal, with global equities reporting their worst firstquarter on record. It was also the worst period for the S&P since the2009 financial crisis, and by March’s close, it was the most volatilemonth on record as economies across the globe were stopped intheir tracks. From the market’s peak on February 19th to its low onMarch 23rd, the S&P 500 lost approximately one-third of its valueover just those few panicked days.

With the increased market volatility, investors sought refuge in saferassets, including lower risk fixed income assets and money marketfunds. In a matter of a few days before the S&P 500 low (March18th), investors transferred record levels of cash from investments tomoney markets.

As a result of the rapid sell-off and escalating economic risks, we arealso seeing an unprecedented level of fiscal and monetary support asthe Fed commits to provide lending to states, local governments andbusinesses, providing credit as needed. And while it is difficult todayto see beyond the current situation, what we are witnessing are anumber of Herculean efforts to mitigate the longer-term economicrisks of this pandemic through these federal programs.

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TAKING THE PLUNGE

Two months ago the U.S. economy appeared to be on a growthtrajectory despite the onset of developing travel and tradecontainment given the virus-awareness in China. Employment datawas still noteworthy, with January’s non-farm payroll rising by225,000 new hires. Hiring strength was across the construction,transportation and service industries as consumer optimism recordedits fifth straight monthly increase (and reaching a 16-year high).

Mid-April and the jobs picture has completely reversed. Over thepast 4 weeks more than 22 million initial jobless claims have beenfiled, with the uninsured unemployment rate jumping to a record 8.2percent. Given the lag in report-counting and stretched governmentagencies, we still expect a further escalation in jobless claims alongwith a spike in the unemployment rate, which by some estimatescould broach 20 percent. IF there is a silver-lining, it is equally aslikely that these trends will reverse once the temporary lay-offsreturn back to work at what many expect will be a rate quicker thanrecoveries from prior economic downturns.

As labor statistics have turned decidedly negative, so has the housingindustry. Two months ago all signals were decidedly positive, withpending home sales up three out of four months, attractive mortgagerates, wage growth and an optimistic consumer. By March, the datahad reversed itself as housing starts plunged in March by -22.3percent, posting the largest one-month drop since 1984. Single-family starts were off -17.5 percent as multi-family starts likewise off-31 percent. Meanwhile the builder optimism index, the NAHB,dropped by 42 points to its lowest level since 2012. From a possiblypositive perspective, these trends could reverse themselves once theeconomy gets back on track and assuming those temporary lay-offsresume their same/similar jobs, mortgage rates continue at theselevels and confidence returns.

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E C O N O M I C C O M M E N TA R Y

CONSUMERS AT A STAND-STILL

As previously highlighted, today’s economic stand-still was not on theconsumer’s mind a few months ago. February’s Michigan ConsumerSentiment Index pointed towards a continuing expansion in March,as was also reflected by the Kansas City Fed Manufacturing Index, theDallas Business Activity Index and the Richmond Fed Services Index.The most recent reports for all reflect a complete reversal in outlookand the current economic reality.

The most recent regional Fed reports have reversed coursehighlighting how quickly the data can change. The most recentPhiladelphia Fed Business Conditions Index fell by -56.6 index pointsto its worst level since 1980 while the New York EmpireManufacturing Index dropped to a record low in April, off -78.2 indexpoints (perhaps good news though was the six-month outlook waspositive). As for Texas, the Dallas Fed’s Texas Manufacturing ActivityIndex hit its lowest point on record. In that context, the most recentFed Beige Book data noted that across all regions, business activitywas described with the following qualifiers: down sharply, broadly,notably or rapidly.

In terms of the U.S Consumer, activity has also come (mostly) to astandstill given the implementation of home-quarantine and today’sgrowing (temporary) layoffs. People are not going to the movies,dining out or traveling. Shopping continues but mostly thanks tohome-delivery services. Today consumers have generally stoppedbuying big ticket items while stocking up at the grocery store. Thischange in consumer behavior is evident in the early retail sales datafor March, which recorded an -8.7 percent drop in store sales. Thedata definitely reflected a stay-at home consumer with clothing storesales off -50.5 percent, auto sales down -25.6 percent, offset partiallyby grocery store sales up +25.6 percent.

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HISTORIC PLUNGES IN OIL PRICES AND ECONOMIC RISK

With most businesses furloughed, fuel demand has fallen quickerthan inventories which has provided little support for energy industrypricing power. As of mid-April, oil prices are near a 22 year lowdespite agreed upon historic production cuts by the OPEC-ledconsortium to cut production by 9.7 billion barrels daily.Unfortunately, demand has fallen faster than production cuts, withgasoline demand off by more than half from last year despite fuel(and oil prices) falling to decade(s) low levels. Meanwhile, overallenergy usage in the United States has fallen to its lowest level in 16years, thanks to so many offices, restaurants and factories closingdown.

Energy demand collapse and its economic risk was reflected in thispast weeks April oil market report from (IEA) International EnergyAgency highlighting that global oil demand is expected to fall by arecord -9.3 million barrels per day. April alone is expected to seeconsumption demand falling to 1995 levels. Refining throughput isalso expected to fall by -7.6 million barrels a day given this sharplyreduced demand for fuels. In terms of electricity usage here in theU.S., the Edison Electric Institute (EEI) noted that demand is down -5.7 percent as compared to the same week in 2019, making this thelowest week for energy use since 2004.

With falling consumer demand and employment levels reflected insharp declines in retail sales, energy demand and the labor markets,it’s not surprising that estimates for Q1 GDP growth are slippingwhile Q2 estimates will likely plummet. Growth estimates (declines)are broad-ranged today with one estimate falling to a negative -10.4percent during this recession. On the positive (recovery side), recentmonetary and fiscal policies should boost total stimulus by up to 25percent of GDP into Q4 2020.

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E C O N O M I C C O M M E N TA R YG L O B A L D Y N A M I C S A N D O U T L O O K

COVID-19 IMPACT

In mid-February global market volatility rose sharply in tandem withincreasing COVID-19 case levels outside of China, crossing over totheir Asian and European neighbors. This unexpected spike led to asharp sell-off in throughout the financial markets as investors soughtsafety from the equity markets. The early sell-off was thenexacerbated in early March as active coronavirus cases in the U.S.began to accelerate.

In an attempt to offset the economic damage from the suddenquarantine efforts, roughly one-third of the global central banksloosened monetary policies over the past few months, cutting ratesby the highest level since the last Great recession. Even so, the IMFhas warned that failure to bring the pandemic under control mightlead to a more prolonged recession. In this scenario the emergingmarkets may be more at risk given depressed commodity prices,falling manufacturing, failing trade and outflows of capital.

With flights, shipments and broad distribution channels disrupted,trade has also come to a near-standstill, with the World TradeOrganization estimating that trade will decline between -13 percentand -32 percent, with exports from North America and Asia expectedto be the hardest hit. The key determinant will hinge on how quicklythe virus is brought under control with some consumer normalcyback in place.

As to the first country impacted by the COVID-19 virus, quarantineefforts and economic downturn, there is some positive signs ofrecovery in China. While the most recent GDP data reflects a GDPdecline of -6.8 percent (and the first decline since 1992), they areoptimistic there will be a turn-around by year-end. During the firsttwo months of the year, exports were off nearly -16 percent, withMarch exports improved slightly to -3.5 percent.

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INVESTOR SELL-OFF

The equity market sell-off that began in late February wasunprecedented, with investor pain spread across most marketsectors, regions and asset classes. At the close of this year’s firstquarter, the equity markets were uniformly negative, with most offat least -20 percent through March. The worst sector performancewas tied to energy, thanks to free-falling oil prices exacerbated by oilsurpluses, collapsing fuel consumption and spats between Russia andSaudi Arabia over production quotas and price supports.

Although all sectors were in negative territory at quarter’s end,market capitalization mattered in terms of performance. Largercompany stocks outperformed their smaller capitalized peers duringthe first quarter, primarily the result of investor concerns relating tofuture economic growth and small company survivability. This wasalso the case related to growth stocks (technology-centric) versusvalue stocks.

From the low point on March 23rd, investors witnessed a significantreversal in the markets. In what has again been a record, therecovery from last month’s bottom through last week (Friday, April17th), the S&P 500 was up nearly 28 percent from its low. Inreviewing the underlying constituents of the S&P 500, most sectorshave similarly recovered, in many cases boosted by consumerdemand for stay at home technology, communication tools andhome delivery channels. On a year-to-date basis though, the S&P500is still 15 percent from its mid-February highs, reflective of investorconcerns relating to the lack of clarity about underlying health fearsand extended recessionary risks.

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GUIDEPOSTS FOR 2020

Given the recent market reversal, investors are looking beyondcurrent COVID-19 cases to the inevitable reboot of global economies.As previously noted, there are signs of life in the Asian markets asChina slowly comes back on line. There is also data pointing to apossible peaking in new cases and the promise of a slow re-openingin the U.S. and overseas. Whether these efforts are premature willbe determined in the future but the timing is becoming a heatedtopic. In the meantime, the equity markets have reflected investoroptimism, bidding up a number of stocks that were selling at bargain-basement prices.

There are a number of issues still confronting the equity marketsdespite (or because) of the strong investor interest in several sectors,such as healthcare, technology and consumer discretionary. On ayear-to-date basis, investors have bid up these three sector weightsby approximately +4.6 percent (through April 17), at the expense ofthe Financial, Energy and Industrial sector weights, likewise off byapproximately -5.6 percent. While understandable given healthcareinterests and the tech-centric needs of those working (orquarantined) at home, there is no visibility yet in near-term earningsestimates, which at this date is sit at a rather conservative -14.5percent for Q1.

What investors also need to be mindful of are the changing dynamicsthat will impact future earnings growth and dividend payments.Stock buy-backs are not likely to follow the trend we’ve seen overthe past decade with companies purchasing $4.3 trillion of their ownshares since the last financial crisis. Companies will likely use cashgenerated from operations to strengthen their balance sheet, whichmay also impact future dividend growth and in a few cases, cutdividends entirely.

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MONETARY POLICY STILL KEY

While more of an undercurrent, the fixed income markets weresubject to the same levels of volatility impacting equity investors,reaching its highest level in the past 15-years over a five day periodending March 19. With uncertainty and liquidity deteriorating,demand for cash and safe assets increased, while interest in credit-related assets plummeted. In this environment, a number of bondclasses were positive during the quarter, with treasuries benefittingfrom risk-averse investors bidding up prices while rates were falling.Over the quarter, longer-duration bonds outperformed those withshorter durations, while corporate bonds turned negative as high-yield bonds lagged investment-grade debt.

In response to the COVID-19 threat, the FOMC dropped the targetrate for Fed funds to zero, cutting rates by 50 basis points (one-halfpercent) on March 3 and 100 basis points (one percent) on March 15.On the latter date the FOMC also committed to using all means at itsdisposal to support credit flows to both businesses and households.While underpinning the markets with historically low rates, thecentral bank also relaxed the leverage ratio that banks were requiredto maintain while also stabilizing a number of funding and liquidityfacilities to manage market credit flows.

Today the Fed is pushing (or eliminating) the limits in order to rebootthe markets once confidence and the economy are on a sure footing.The Federal Reserve is once again in the Quantitative Easingbusiness, buying government bonds, mortgage-backed bonds andsecuritized debt while also supporting loans made to small and mid-size companies. More support is likely to come, as the Fed’s balancesheet is up by +/- 50 percent to $6.4 trillion.

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This commentary is furnished for informational purposes only and is not investment advice, a solicitation, an offerto buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughtsare as of the date given and are subject to change without notice. The information presented in this commentarywas obtained from sources and data considered to be reliable, but its accuracy and completeness is notguaranteed. It should not be used as a primary basis for making investment decisions. Consider your ownfinancial circumstances and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions.Forward-looking statements are not indicators or guarantees of future performance and involve certain risks anduncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversificationstrategies do not ensure a profit and cannot protect against losses in a declining market. All indices areunmanaged and investors cannot invest directly into an index. You should not assume that an investment in thesecurities or investment strategies identified was or will be profitable.

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