Addressing market volatility, a message from Mercer, the DAP Investment Advisor (as of March 20, 2019)
Recent Developments
Last week, the World Health Organization declared COVID-19 a global pandemic. As the number of cases continues to grow, governments and health services around the world are scrambling to contain the spread of the virus. Tragically, the death toll is continuing to rise intensifying fear and panic. The economic damage resulting from business disruption has been severe and a global recession now appears likely. The depth of an impending recession and shape of a recovery (i.e. V-shaped, U-shaped) depends on how quickly the outbreak can be brought under control. One of the most striking fallouts has been the combination of a supply-side and demand-side shock of oil leading to its price collapse. This resulted when Saudi Arabia increased production just as countries began to ground flights, and commuting as well as other forms of travel significantly declined. The longer-term results of this are difficult to predict. On one hand, low oil prices can act as a stimulus, as energy accounts for a large chunk of consumer expenses. On the other hand, a high concentration of energy and energy equipment suppliers at lower-rated segments of the bond market (high yield bond issuers) can create a vicious cycle of rising defaults resulting in significant market stress. This makes refinancing for some energy industry participants more difficult and can lead to further defaults. As with the collapse in oil prices during 2015 and 2016, reductions in jobs and investments by energy companies could more than offset any stimulatory impact of low oil prices, given the economic influence of shale gas in the US. This has not escaped the markets. A downward trend that began around February 12 culminated in what has already been dubbed ”Black Thursday” on March 12 — the worst one-day equity market crash since Black Monday in October of 1987. Following a recovery the following day, equity markets crashed by even more on March 16. Recently, risk assets have taken a substantial hit, whereas safer assets have performed well, as expected in such an environment. Bonds have outperformed equities and real estate while higher quality bonds (i.e. Treasuries, AAA-rated) have outperformed lower-rated bonds (low investment grade BBB-rated, high yield bonds).
Unlike in 2008, the structure of the financial system has held up reasonably well so far. There are no widespread doubts about the stability of banks, and central banks have acted quickly to provide liquidity, even if it is not yet clear how effective this may be. Central banks and policymakers today are in greater alignment and have committed to stand by with monetary and fiscal stimulus actions. Additionally, a significant portion (though not all) of the market decline has been driven by uncertainty, not fundamentals such as the case in 2008. We do not yet know what the full extent of the pandemic will be or which companies it will affect over the long term. The main concern is an escalation in the US and the impact of enforced lockdown measures like those seen in Italy and China. This would likely inflict a deep wound on global markets given the sheer market capitalization of the US.
Portfolio Implications and Call for Action
Recent market movements have caused most participants’ portfolios to veer from their target asset allocation. Participants’ managing their own asset allocation strategy should review their portfolios and consider rebalancing their exposure at least part of the way back toward their target allocation. Rebalancing can potentially enhance return, but most importantly, it is a risk-control measure. Markets will ultimately touch bottom and rebound, and in the absence of rebalancing, it would be difficult for the portfolio to keep up with a policy benchmark and recover lost value. The bottom-line, Mercer believes that adhering to a disciplined asset allocation strategy benefits a portfolio’s long-term return and risk profile. Please keep in mind that the Tier I – Asset Allocation funds are professionally managed and rebalance periodically to the target allocations on their own. The Tier I investment options include all of the Vanguard Target Retirement Funds, Income Fund, Conservative Fund, Moderate Fund and Aggressive Fund.
Previous Heads Up Newsletters Addressing Market Volatility – The DAP has been in service for over 26 years and experienced many times where we had to educate our participants on market volatility and downturns. We have experienced several markets that put people in crisis mode such as the dot com crisis, the millennium looming, 9/11 and the 2008 banking crisis. These articles below withstand the test of time.
April 2018 Heads Up Newsletter What is Market Volatility?
April 2015 Heads Up Newsletter Riding Along with the Ups and Downs
April 2011 Heads Up Newsletter Staying the Course
October 2009 Tips for Surviving the Next Disaster
October 2008 Market Declines – A History Lesson Revisited
October 2007 Market Timing – Put Down that Watch, You Can’t Time the Market
October 2002 Market Declines – A History Lesson
November 1999 Market Volatility, The Millennium Looms
May 1996 When the Teacup Rattles in the Saucer; The Risk of Being Out of The Market
December 1994 Slow and Steady Wins the Race; Buy and Hold as Market Timing
August 1994 Watch the Donut, Not the Hole; Analyzing Performance using Benchmarks
