Financial markets do not abide by the calendar—they don’t stop on December 31 then restart the next day. Even so, it makes sense to pause to reflect on events from the prior 12 months. These musings tend to span the gamut—from tried-and-true tenets to once-in-a-lifetime teachings. And 2020, a year of truly exceptional circumstances, is no different.
Hindsight Is 2020
Here we discuss the top five lessons that shaped our allocation perspectives:
1. Don’t fight the Fed. While this isn’t a novel take, it’s easy to forget it in the eye of the storm. The Federal Reserve’s actions were crucial in stabilizing the markets at the depths of the pandemic. They started with consecutive moves lowering its target rate by 50 basis points on March 3 and another 100 basis points on March 16. The Fed then supplemented with targeted programs to backstop the credit markets and provide liquidity—a truly unprecedented situation. Importantly, these actions also gave fixed-income investors confidence to reengage.
When combined with the $2.3 trillion CARES Act enacted on March 27, the speed and magnitude of the Fed’s support ensured that the economy didn’t completely fail as shelter-in-place orders took effect.
The Fed’s response to this health crisis was significantly faster than its response to the Global Financial Crisis (GFC) (Display). Back then, the Fed Funds target rate fell to around zero 600 days after the onset—this time, intervention took only 100 days.
Fiscal stimulus was also concerted and swift, but the Fed led the way with its creative and aggressive initial response—which sent a powerful sign to investors about their willingness to support liquidity.
Lesson Learned: The rapid response, in conjunction with other factors, laid a solid foundation from which the market could recover from an initial drawdown of over 30% within 120 days. Investors that “fought” the Fed’s actions missed out.
2. Even bonds can be volatile in the short term. One of the most significant surprises of 2020 was the intermittent volatility of bonds. Municipal bonds saw a peak-to-trough drop of 9% in one month—followed by an equally rapid recovery.
The extreme move was in part a manifestation of fears that state budget shortfalls would rival those of the GFC and the recession that followed. But no state has defaulted since the Great Depression. And with today’s ample liquidity and market access, not a single state is even close to missing a payment. Simply put, municipalities are in far better shape than before 2008.
Yet at the depths of the health crisis, investors failed to consider the strength of municipalities’ balance sheets. Instead, they sold bonds at whatever price the market would bear. This “fire sale” pricing exacerbated an already stressful period. Despite this initial pain, muni bonds bounced back and posted gains for the full year.
Lesson Learned: Even bonds aren’t immune from short-term bouts of trading volatility. But they reward investors willing to look past the noise and focus on long-term investing. In this cycle, municipal bonds remain on solid financial footing.
3. Beware of chasing the “hot dot”. It’s easy to go along with the crowd and invest in the sectors du jour. But mind the ticking clock before the fad fades! While being a disciplined investor tests the natural human tendency to seek success, patience often results in compelling long-term returns. Just look at the outcome for non-US stocks following the reopening of global economies. After underperforming the US at the beginning of 2020 and through the early days of the crisis, non-US stocks outperformed as recovery took hold (Display).
Out-of-favor styles and asset classes like value and small-cap stocks followed a trajectory similar to non-US equities. But while they moved higher during stretches of 2020, it hasn’t been a straight climb. Could these securities be on the cusp of a prolonged run, or was it just a short-term reversal?
Lesson Learned: Discipline pays off—but it can be painful to wait.
4. Many trends aren’t new; they’ve just accelerated. The pandemic has cemented several recent developments, from enabling work-from-home and an explosion in mobile payments to the growing interest in environmental, social, and governance (ESG) investing. These trends were already afoot—the crisis just hastened their uptake. E-commerce is a good example. Brick-and-mortar retailers have been losing sales to online retailers for years (Display), but as stay-at-home orders spread throughout the country, the pace of e-commerce adoption surged.
The same can be said for responsible investing. While it’s gained popularity (and assets) over the last few years, George Floyd’s death sparked a social justice revolution, amplifying shareholders’ calls to address the lack of diversity in corporate America.
Lesson Learned: Silver linings can be borne out of tragedy. The pandemic catalyzed a number of trends which we believe are here to stay.
5. Resiliency comes from trials and tribulations. The COVID-19 pandemic is the global tragedy of this generation, similar to what WWII meant to earlier generations. But amid the crisis, several unexpected things occurred. Individuals slowed down and reconnected with family and close friends. Amazing acts of humanity and kindness emerged, including universal support for essential workers and those most in need. Americans banded together—collecting food for furloughed workers, computers for school children, and tablets for hospitalized patients to communicate with families—while donors stepped up to the plate, increasing charitable giving by 30% so far this year.*
Resilience could be found everywhere: at home as kids adapted to online learning, at workplaces that moved to operate remotely, and by our clients who adapted to a new kind of partnership with us. Microsoft CEO, Satya Nadella, summed up the magnitude of the situation, “In this era of remote everything, we have seen two years’ worth of digital transformation in two months.”**
This is the greatest and most important lesson of all. We mourn the loss of the more than 350,000 Americans who have passed from the coronavirus, but we also celebrate the kind of American innovation and resilience embodied by the COVID-19 vaccine. The discovery, testing, and manufacturing of several vaccines in such a short time frame epitomizes the pioneering spirit that built America and will continue to push her forward.
Lesson Learned: Never count America out. We will rise from this enormous generational challenge with our character and resilience leading the way forward.
- Beata Kirr
- Co-Head—Investment Strategies
- Alexander Chaloff
- Co-Head—Investment Strategies