indicatorCompass Commentary

Portfolio Manager's Commentary

March, 2020 performance report


A quarter that began quite conventionally ended very unconventionally, as the rapid spread of the COVID-19 illness and the public health measures enacted to slow its spread became all-encompassing. Stock and corporate bond prices fell sharply in anticipation of the looming economic slowdown caused by the health measures.

By quarter end, public life became progressively more restricted, beginning with social distancing requirements but then moving to the closure of schools and the shutdown of non-essential businesses (unless their employees could work remotely). This pattern was much the same elsewhere, as humanity worldwide began to "hunker down" in a common battle against a fast-moving adversary.

The economy

The restrictions enacted to slow the virus's spread and not overburden the health care system were unparalleled in their speed and scope. In barely three weeks a large portion of the North American workforce began to work from home, while others who could not were essentially furloughed.

Such broadly implemented restrictions on both production and consumption is already negatively affecting economic output. The most recent applications for unemployment insurance indicate that about 7.5% of the US and 10% of the Canadian workforces became unemployed. In comparison, the largest single-month rise in the official unemployment rate since records were first kept was 1.3% in the US and 1% in Canada.

Government response

Having created a steep economic slowdown for public health reasons, governments quickly took steps to minimize further economic fallout. The US federal government signed a $2.2 trillion fiscal stimulus package to aid individual Americans and businesses. The Canadian federal government undertook similar temporary fiscal stimulus measures, including most prominently a $2000 per month payment for those who lost their jobs and a 75% wage subsidy for badly affected businesses.

Central bank response

Central banks also sprang into action to limit the collateral damage from the public health measures. The US and Canadian central banks each cut their short-term interest rate targets to nearly zero percent.

Even more important were steps the central banks took to keep credit flowing. The US Federal Reserve ("Fed") expanded several existing programs and created several new ones to support the flow of credit to businesses, consumers and municipalities. The Bank of Canada followed suit with several measures to support the functioning of markets for short-term commercial and provincial debt, other measures to support liquidity for Canadian banks, and for the first time included "quantitative easing" (the purchase of federal government bonds) in its monetary policy arsenal.

The government and central bank actions will not stop the initial economic contraction, which has largely occurred as the unfortunate byproduct of the public health measures. However, the government's fiscal stimulus can prevent the slowdown from turning into a much deeper and prolonged recession, and the central bank actions can prevent the financial sector from "gumming up" or even collapsing, as occurred during the 2008 financial crisis. Essentially, the first train car has already derailed, but government and central bank action can keep the rest of the cars on the tracks so that they start moving quickly when the pandemic eventually passes.

Financial markets

Stock markets swung violently and dropped sharply in March as the looming economic slowdown weighed heavily on investors. At one point the S&P 500 index of US large-company shares was nearly 35% lower than in mid-February, and daily price swings of 10% in either direction occurred several times. However, the emotional extremes began to subside as the quarter concluded.

Source: Standard & Poors


Corporate bond prices also dropped significantly in March, as companies' ability to service their debt was expected to deteriorate. Government bond returns were positive but their already-low interest rates ("yields") were reduced even further. For example, the Canadian federal government 10-year bond yield was only 0.71% on March 31.

Compass Portfolios

The Compass Portfolio returns for the quarter were negative, reflecting the large declines among nearly all asset classes. The returns ranged from -5.5% for the most conservative to just below -17% for the most aggressive.

Source: Morningstar


Within the Compass Portfolios, nearly all the actively-managed equity components outperformed their benchmarks. However, all three actively-managed fixed income components underperformed due to their positioning in corporate bonds or "credit", as the safety of government bonds attracted demand and corporate bonds did the opposite. Despite their cautious positioning, mainly short-maturity holdings of higher credit quality, these components were still affected by the corporate bond selloff.

The Compass Portfolio returns were also slightly negatively affected in the quarter by their currency hedges, which partially insulate them from ongoing foreign currency fluctuations. As the oil price fell to only $20 per barrel during March, the hedges prevented the portfolios from fully participating in commensurate increase of the US dollar against the Canadian dollar.

Conclusion

After a tumultuous quarter, it feels like we're now at the end of the beginning: society is acutely aware of the COVID-19 danger, most of the public health-related restrictions that can be imposed have been imposed, the primary employment and economic effects of those restrictions are much clearer, governments and central banks are responding aggressively to minimize further economic fallout, and financial market volatility is starting to recede.

What makes this economic slowdown and stock market decline unique is that they resulted from government and social response to a pandemic, a situation North America last encountered during the 1918-19 Spanish Influenza. What is not unique is that, as in every recession, companies' profitability will initially erode and then eventually more than recover as the recession ends. What is also not unique is that stock prices in a rapidly changing economic environment will at first be very volatile, and then will dampen out as emotional extremes dissipate. We've very quickly entered the painful part of investing in stocks, but this pain is the short-term cost investors must occasionally bear in order to participate in stocks' superior long-run returns.

Where does this leave investors? Despite the emotional roller coaster, it's imperative for investors to continue to follow a long-term plan, one designed to achieve their investment goals despite the bumpy path. Only three months ago, when the economy was sound and investors' mood was quite positive after a good year, we wrote in this space that "the best reaction to financial market gyrations is usually no reaction at all." This advice sometimes seems very difficult to follow but we've offered it continually since the Compass Portfolios' 2002 inception, and it remains as relevant today as it always was.


Gene Hochachka
Chief Investment Officer
ATB Investment Management Inc.

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