Commentary Archive 2020

Commentary Archive 2019 background

Commentary Archive 2020

Disclosure

Performance results are based on estimates. Although the information contained in the commentary sections have been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. Past performance is not necessarily indicative of future results. Different types of investments involve varying degrees of risk.

FIRST QUARTER 2020

Hanseatic Market Commentary

The past three months have been very difficult and chaotic for all equity markets. After posting multi-year highs on February 19th, the markets collapsed in response to news of the serious nature of the coronavirus disease (COVID-19). The drop in stock market prices continued in the following three weeks until the market found a bottom on March 23rd that has held into early April.

The S&P 500 ended the quarter with a decline of 20%, while the Mid-Cap and Small-Cap benchmarks had even worse declines of 30% and 33% respectively.

For the S&P 500, it was the fifth quarterly drop of 20% or more in the post-World War II era. Notably, for the six and twelve month periods following the previous quarterly declines of 20% or more since 1945, the index was higher each time.

ECONOMY

The COVID-19 outbreak and the full scope of its negative economic impact are difficult to discern given the uncertainty about the number of people infected, the transmission rate, and the longevity of the illness. But we now have a concrete indication that the toll from the disease is affecting a significant share of the U.S. economy when it was reported that 6.6 million Americans applied for unemployment benefits last week. This number was double the 3.3 million who sought benefits last month as large parts of the economy were shut down in an effort to contain the spread of the virus. It is clear that the labor market freefall is unprecedented as is the notion that the government would be compelled to shutter virtually the entire U.S. economy for health reasons.

With consumer spending, which represents 70% of the U.S. economy, contracting rapidly and likely remaining constrained for the next few months, a temporary recession is virtually unavoidable.

VALUATIONS

A positive development from all the market turmoil is that stock valuations have, by any measure, improved significantly. Even as stocks were making new highs in February, they were only moderately overvalued from the perspective of both forward and trailing price/earnings ratios. Now, following dramatic price declines across the board, stocks in general present compelling valuations. Some companies are cheap for a reason, but many stocks are at fire sale prices because they have been victims of crisis conditions and forced selling. Stocks are even more compelling on a relative yield basis with the 10-year Treasuries yielding 0.63% and the S&P 500 dividend yield of 2.44%.

FED/GOVERNMENT POLICIES

There has been some good news of late. Both the Fed and the federal government have stepped in to help stabilize the economy providing the foundation to promote its growth down the road. The Fed has cut rates to zero, started a new round of quantitative easing, and undertaken a series of unprecedented measures to bolster economic growth and stabilize the economy.

The federal government has implemented a $2 trillion stimulus plan that supports worker incomes, distressed companies, and some of the hardest-hit industries.

A proactive Fed and Congress are crucial. Their initiatives cannot cure the health crisis, but they should help boost confidence and support a rebound in growth in the months ahead.

CYCLICAL vs. SECULAR BEAR MARKET

We believe we are in a cyclical rather than a secular bear market. The primary difference involves both the duration and magnitude of decline. For starters, it is important to understand that there was nothing dangerously wrong with the economy before the pandemic struck. As noted earlier, valuations were somewhat stretched, but nothing like they were before the busting of the dot-com bubble. Nor was the economy burdened with the excesses in leverage, real estate debt and banking vulnerabilities that were exposed in the last financial crisis. Nor are there any of the 1970-80s inflationary excesses that prompted an upward spiral in interest rates. Rather, this crisis was caused by the health and economic impacts of the largely unforeseen pandemic.

We believe the distinction between the causes of the prior secular bears and the current bear market is significant and warrants the conclusion that this bear market is more akin to be like the 1987 market crash or the correction following 9/11. Rather than taking nearly two years for the market decline to reach a point where the risk-reward relationship for equities is attractive, we believe that point has already been reached. While we believe more volatility and perhaps modestly lower prices are still ahead, we think the probabilities favor a market bottom within the next few months.

LOOKING AHEAD

The pandemic is still expanding and likely to continue doing so for the next 1-2 months. The empirical economic damage is just starting to be visible, so there will be plenty of frightening headlines and dire forecasts, especially during the month of April.

From a public health standpoint, the underlying trends will continue to improve. The outlook for meaningful progress on controlling the virus is promising based on the impact of social distancing, increased testing availability, and treatment advances.

The markets may also react to the headlines in the short term. But there is an important difference with the equity market, in particular, in that it is essentially a discounting mechanism that looks forward and evaluates the probabilities for the investment environment ahead rather than current data.

HANSEATIC QUARTERLY STRATEGY PERFORMANCE AND ATTRIBUTION

LARGE CAP EQUITY (LG)

The Large Cap Equity strategy return was down 16.54%, the Russell 1000 Growth benchmark return was down 14.10%. The strategy’s first quarter underperformance was derived from relative underperformance in six of eleven sectors. Communication Service and Healthcare contributed 1.25% and 1.17% respectively to relative performance. Real Estate, Staples, and Energy contributed a combined 0.33% to relative performance. Consumer Discretionary, Financials, and Industrials detracted 1.88%, 1.16%, and 1.13% respectively from relative performance. Technology, Materials, and Utilities detracted a combined 1.04% from performance. The strategy is overweight Technology and underweight Consumer Discretionary.

ALL CAP GROWTH EQUITY (AG)

The All Cap Growth Equity strategy return was down 17.53%, the Russell 3000 Growth benchmark return was down 14.85%. The strategy’s first quarter underperformance was derived from relative underperformance in three of eleven sectors. Healthcare, Industrials, Staples, and Real Estate contributed 0.87%, 0.68%, 0.47%, and 0.24% respectively to relative performance. Materials, Energy, Communication Services, and Utilities contributed a combined 0.36% to relative performance. Consumer Discretionary, Technology, and Financials detracted 2.76%, 1.98%, and 0.75% respectively from relative performance. The strategy is overweight Healthcare and Technology and underweight Communication Services, Industrials, and Consumer Discretionary. The strategy has a higher than normal combined cash and a defensive (IEF) position of ~15%. The IEF position contributed 0.19% to relative performance.

ALL CAP GROWTH CONCENTRATED EQUITY (CD)

The All Cap Growth Concentrated Equity strategy return was down 22.05%, the Russell 3000 Growth benchmark return was down 14.85%. The strategy’s first quarter underperformance was derived from relative underperformance in four of eleven sectors. Healthcare, Staples, and Communication Services contributed 0.78%, 0.74%, and 0.37% respectively to relative performance during the quarter. Materials, Real Estate, Energy, and Utilities contributed a combined 0.65% to relative performance. Technology, Financials, Consumer Discretionary, and Industrials detracted 6.09%, 1.38%, 1.32%, and 1.03% respectively from relative performance. The strategy is overweight Healthcare and Communication Services and underweight Consumer Discretionary, Technology, and Industrials. The strategy has a higher than normal combined cash and a defensive (IEF) position of ~26%. The IEF position contributed 0.10% to relative performance.

ALL CAP TAX EFFICIENT EQUITY (TE)

The All Cap Tax Efficient Equity strategy return was down 17.06%, the Russell 3000 benchmark return was down 20.90%. The strategy’s first quarter outperformance was derived from relative outperformance in seven of eleven sectors. Industrials, Financials, Real Estate, and Energy contributed 2.50%, 2.06%, 1.56%, and 1.43% respectively to relative performance. Materials, Communication Services, and Staples contributed a combined 0.95% to relative performance. Technology, Consumer Discretionary, Healthcare, and Utilities detracted 2.45%, 1.54%, 0.50%, and 0.24% from relative performance. The strategy is overweight Materials and Healthcare and underweight Industrials, Technology, and Financials. The strategy has a higher than normal combined cash and a defensive (IEF) position of ~18%. The IEF position contributed 0.08% to relative performance.

MID CAP EQUITY (MC)

The Mid Cap Equity strategy return was down 21.57%, the Russell Midcap Growth benchmark return was down 20.04%. The strategy’s first quarter underperformance was derived from relative underperformance in five of eleven sectors. Communication Services, Industrials, and Energy contributed 1.08%, 0.99%, and 0.38% respectively to relative performance. Materials, Real Estate, and Utilities contributed a combined 0.54% to relative performance. Healthcare, Consumer Discretionary, Staples, Technology, and Financials detracted 1.74%, 1.43%, 0.65%, 0.43%, and 0.28% respectively from relative performance. The strategy is overweight Healthcare and Technology and is underweight Industrials and Financials.

SMALL CAP EQUITY (SC)

The Small Cap Equity strategy return was down 25.97%, the Russell 2000 Growth benchmark return was down 25.76%. The Small Cap Equity strategy’s first quarter underperformance was derived from relative underperformance in three of eleven sectors. Industrials, Communication Services, and Real Estate contributed 3.51%, 1.14%, and 0.96% respectively to relative performance. Financials, Utilities, Energy, Technology, and Staples contributed a combined 0.89% to relative performance. Healthcare, Consumer Discretionary, and Materials detracted 4.15%, 1.33%, and 1.23% respectively from relative performance. The strategy is overweight Healthcare, Communication Services, and Technology and underweight Industrials, Financials, and Real Estate.

GROWTH & INCOME EQUITY (GI)

The Growth & Income Equity strategy return was down 22.22%, the S&P 500 Total Return Index return was down 19.60%. The strategy’s first quarter underperformance was derived from relative underperformance in eight of eleven sectors. Communication Services, Industrials, and Energy contributed 2.66%, 1.78%, and 0.73% respectively to relative performance. Technology, Utilities, Real Estate, and Consumer Discretionary detracted 1.96%, 1.57%, 1.53%, and 1.23% respectively from relative performance. Materials, Staples, Financials, and Healthcare detracted a combined 1.88% from relative performance. The strategy substantially reduced exposure across all sectors during the quarter. The strategy has a higher than normal combined cash and a defensive position of ~50%. The defensive position is made up of IEF and a diversified balance of other instruments representing the HD Conservative strategy. The portions of the Growth & Income strategy that have been historically defensive during periods like February and March were not spared during the market panic. Although these are uncertain times, the portfolio team determined the best course of action was to diversify the risk component of the current portfolio into a defensive strategy that was not concentrated in any particular segment of the stock or bond market until there is more clarity on what happened to these historically defensive sectors during this recent period. There is speculation that substantial leverage was in place from hedge funds and forced liquidations occurred in March resulting in more downside pressure in these historically uncorrelated segments of the stock market. Looking forward, the team will be seeking opportunities when the risk has subsided. The process has performed very well in the past coming out of these corrections and the probabilities favor a similar scenario this time.

BALANCED RISK (BR)

The Balanced Risk strategy return was down 9.62%, the S&P Target Risk Moderate Index return was down 8.62%. The strategy’s first quarter underperformance was derived from negative performance in Dividend Yielding stocks, Emerging Market bonds, Utilities, Consumer Staples, High Yield bonds, and Investment Grade bonds, all were lower during the quarter. The strategy is ~40% defensive equities and ~60% fixed income (rebalanced 4/1/2020). The portions of the Balanced Risk strategy that have been historically defensive during periods like February and March (Staples and Utilities) were not spared during the market panic. There is speculation that excessive leverage was in place from hedge funds and forced liquidations occurred in March resulting in more downside pressure in these historically uncorrelated segments of the stock market.

CONSERVATIVE RISK (CR)

The Conservative Risk strategy return was down 2.30%, the S&P Target Risk Conservative Index return was down 6.23%. The strategy’s first quarter outperformance was derived from positive performance in Intermediate Term bonds. The strategy is ~20% defensive equities and ~80% fixed income. The portions of the Conservative Risk strategy that have been historically defensive during periods like February and March (Staples and Utilities) were not spared during the market panic. There is speculation that excessive leverage was in place from hedge funds and forced liquidations occurred in March resulting in more downside pressure in these historically uncorrelated segments of the stock market.

HD Strategy Introduction (February and March 2020)

Dynamic portfolio strategies are a methodology which enables clients to make strategy choices among a range of return and risk preferences. Each strategy is diversified among the equity, fixed income, real estate, precious metals, and cash equivalent asset classes. The dynamic feature of the strategy means that disciplined quantitative models dynamically overweight and underweight the underlying components within the asset class. In the case of equities, for instance, the models might overweight Technology relative to Healthcare or cyclical sectors. All weightings are calculated and reviewed on a monthly basis. The overall objective of dynamic strategies is to maximize portfolio return for a given range of risk.

The performance for February and March are reflected on the current performance table. All strategies performed well during the initial period. The market behavior during that time was as severe a test as we have seen in the last decade for the strategies. For more information on the new HD strategies please contact clientservices@hanseaticgroup.com.

LATIN AMERICA EQUITY (LA)

The Latin America Equity strategy return was down 51.62%, the MSCI EM Latin America Index return was down 45.96%. The strategy’s first quarter underperformance was derived from negative performance in eight of eleven sectors. Industrials, Financials, Utilities, Energy, Staples, Communication Services, Materials, and Technology detracted 16.04%, 9.25%, 9.00%, 7.80%, 4.00%, 3.20%, 1.86%, and 0.90% respectively from performance. There was no exposure to Consumer Discretionary, Healthcare or Real Estate. The strategy has a 17% cash position currently and 30% exposure to the ILF. The collapse in Energy prices also contributed to the overall panic seen in global markets during the quarter.