Quarterly Investment Review

A message from the Investment Management Team of Strategic Advisers LLC

By Brian Enyeart, CFA®,* President, Strategic Advisers LLC- First Quarter 2020

First Quarter 2020: Market Summary

THE COVID-19 OUTBREAK LED TO MARKET VOLATILITY

Global stocks fell amid concerns surrounding the impact of the COVID-19 outbreak on corporate earnings. Investment grade bonds rose, but experienced unusual volatility.

U.S. ECONOMY STANDS AT THE ONSET OF RECESSION

We believe the U.S. economy is likely to contract, as efforts to manage the spread of the virus have led to a sharp drop in demand for goods and services from consumers and businesses.

WATCHING FOR EARLY SIGNS OF MARKET STABILIZATION

We’re closely watching efforts to manage the spread of the virus and for signs of economic activity, as positive developments may lead to greater stability in stock and bond markets.

Preparing and positioning portfolios for the onset of recession

 Last quarter, U.S. stocks fell 21.0%¹ while bonds experienced unusual volatility amid market concerns that efforts to suppress the spread of COVID-19 would lead to slower economic growth. This market volatility led to a difficult quarter for many client accounts. However, over the last few years, we had reduced exposure to riskier assets such as stocks within client portfolios. We took these actions because we believed economic growth was maturing and the United States was moving into the late phase of the business cycle. As a result of these actions, well-diversified client accounts experienced less volatility than they may have otherwise.

We now believe that the U.S. economy is at the onset of a recession. Therefore, towards the end of the quarter, we further reduced exposure to both U.S. and international stocks within well-diversified client accounts, while allocating more to investment grade bonds. Historically, stocks have experienced greater volatility during recessions, followed by strong recoveries as the economic backdrop has improved. Meanwhile, bond investments may offer stability for investors during periods of stock market volatility.

Finding opportunities to rebalance client accounts

Periods of heightened market volatility also provided opportunities for us to rebalance client accounts. Our disciplined rebalancing process helped to:

• Keep your investments aligned to your financial goals.
• Discover opportunities to buy stocks at lower prices after market declines. These opportunities may lead to investment gains in an eventual stock market recovery.

Growth, quality, and large company stocks provided stability within US markets

Over the last few years, we have emphasized allocations to growth, quality, and large company stocks.

Here’s how those areas of the market performed during the quarter:

• In sharp contrast with the broader stock market, Growth stocks fell by only 14.1%². As expected, value stocks dramatically diverged from growth stocks returning -26.7%³. Value stocks tend to struggle at the onset of recessions, as investors express near-term doubts about the outlook for some of these companies.        
• Quality stocks, which are companies with low debt and stable earnings, also outperformed the U.S. stock market with a return of -15.0%⁴. Quality stocks typically hold their value better versus the broader market during periods of volatility.
• Finally, larger companies often perform better than smaller ones during recessions and other periods of market stress. Over the quarter, large companies outperformed small companies by a notable 10.4%⁵.

Quality, growth, and China stocks provided stability within international stock investments

Over the quarter, international developed markets and emerging markets trailed U.S. stocks, returning -22.8%⁶ and -23.6%⁷, respectively.

Within our allocations to international stocks:

• In developed markets, our increased allocations to quality and growth stocks protected client accounts against more severe stock market drops. Quality and growth stocks outperformed international developed markets by 7.3%⁸ and 5.3%⁹ respectively.
• In emerging markets, exposure to China provided some protection from large declines in emerging market stocks. China stocks have held up relatively well when compared to the rest of world. In fact, China stocks experienced the highest relative performance for the quarter within emerging markets

Bonds provided stability in spite of brief periods of volatility 

A combination of lower interest rate policies by the U.S. Federal Reserve and falling investor expectations for U.S. economic growth led to lower bond yields. Lower yields helped investors as bond prices rose.

• Due to the size of the Chinese economy and its importance to other countries, developments in these areas may be critical to the global economy in 2020. 
• We remain dedicated to watching for shifts in the economy that will help inform the prudent investment decisions that we make on your behalf. 

Our outlook: following COVID-19 developments, support from policymakers, and economic indicators

We are closely following efforts to manage the outbreak, and the overall economy, for signals that some of the economic disruptions due to the virus may be behind us. Some key areas that we continue to monitor include:

• Hospitalization rates from COVID-19
• New developments in therapies to treat virus patients, or efforts toward developing an eventual vaccine
• Efforts by governments and central banks to support the global economy
• Trends in jobless claims and consumer spending to measure economic activity

We believe markets may remain volatile. The COVID-19 outbreak has led to uncertainty surrounding the pace of economic growth and the outlook for corporate profits. However, we have experienced markets like these before in the face of many past economic challenges. We are confident that the U.S. economy will eventually find its footing, leading to an eventual early cycle expansion. Through it all, we remain committed to taking a patient, disciplined approach to managing your investments, while seeking opportunities to help you achieve your financial goals. 

* The CFA designation is offered by the CFA Institute. To obtain the CFA charter, candidates must pass three exams demonstrating their competence, integrity, and extensive knowledge in accounting, ethical and professional standards, economics, portfolio management, and security analysis, and must also have at least four years of qualifying work experience, among other requirements.

¹ Dow Jones U.S. Total Stock Market Index

² Russell 1000 Growth Index

³ Russell 1000 Value Index

⁴ MSCI USA Quality Index

⁵ Russell 1000 Index minus Russell 2000 Index

⁶ MSCI EAFE Index (Net MA Tax)

⁷ MSCI EM Index (Net MA Tax), respectively

⁸ MSCI EAFE Quality Index

⁹ MSCI EAFE Growth Index (Net MA Tax)

¹⁰ Bloomberg Barclays U.S. Aggregate Bond Index

¹¹Tax-smart (i.e., tax-sensitive) investment management techniques, including tax-loss harvesting, are applied in managing certain taxable accounts on a limited basis, at the discretion of the portfolio manager, primarily with respect to determining when assets in a client's account should be bought or sold. Assets contributed may be sold for a taxable gain or loss at any time. There are no guarantees as to the effectiveness of the tax-smart investment techniques applied in serving to reduce or minimize a client's overall tax liabilities, or as to the tax results that may be generated by a given transaction.

​Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Past performance is no guarantee of future results.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

Indexes are unmanaged. It is not possible to invest directly in an index.

The views expressed in the foregoing commentary were prepared by Strategic Advisers LLC based upon information obtained from sources believed to be reliable but not guaranteed. This commentary is for informational purposes only and is not intended to constitute a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The information and opinions presented are current only as of the date of writing without regard to the date on which you may access this information. All opinions and estimates are subject to change at any time without notice.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, all of which may be magnified in emerging markets.

Lower-quality debt securities generally offer higher yields, but they also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible.

Investments in smaller companies may involve greater risk than those in larger, more well‐known companies.

Because of their narrow focus, sector funds tend to be more volatile than funds that diversify across many sectors and companies.

Index information:

Securities indexes are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Benchmark returns assume the reinvestment of dividends and interest income. Investments cannot be made directly in a broad‐based securities index.

• The Dow Jones U.S. Total Stock Market Index is a float-adjusted, market capitalization–weighted index of all equity securities of U.S.-headquartered companies with readily available price data.
• The Russell 1000 Growth Index is a market capitalization-weighted index designed to measure the performance of the large cap growth segment of the U.S. equity market. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth rates.
• The Russell 1000 Value Index is a market capitalization-weighted index designed to measure the performance of the large cap value segment of the U.S. equity market. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth rates.
• The MSCI USA Quality Index is based on the MSCI USA Index, its parent index, which includes large and mid cap stocks in the U.S. equity market. The index aims to capture the performance of quality growth stocks by identifying stocks with high quality scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage.
• The Russell 1000 Index measures the performance of the large-cap segment of the US equity universe. It is a subset of the Russell 3000® Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000® represents approximately 92% of the US market. The Russell 1000® Index is constructed to provide a comprehensive and unbiased barometer for the large-cap segment and is completely reconstituted annually to ensure new and growing equities are included.
• The Russell 2000 Index measures the performance of the small-cap segment of the US equity universe. The Russell 2000® Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. The Russell 2000® is constructed to provide a comprehensive and unbiased small-cap barometer and is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set.
• The MSCI EAFE Index (Net MA Tax) is an unmanaged, market capitalization–weighted index of equity securities of companies domiciled in various countries. The index is designed to represent performance of developed stock markets outside the United States and Canada, and excludes certain market segments unavailable to U.S.-based investors. The index returns for periods after 1/1/1997 are adjusted for tax-withholding rates applicable to U.S.-based mutual funds organized as Massachusetts business trusts.
• The MSCI EM Index (Net MA Tax) captures large and mid-cap representation across 26 Emerging Markets (EM) countries. Emerging market countries include: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. With 1,401 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country. The index returns for periods after 1/1/1997 are adjusted for tax-withholding rates applicable to U.S.-based mutual funds organized as Massachusetts business trusts.
• The MSCI EAFE Quality Index is an unmanaged, market capitalization–weighted index of equity securities of companies domiciled in various countries. The index is designed to represent performance of developed stock markets outside the United States and Canada, and excludes certain market segments unavailable to U.S.-based investors. The index aims to capture the performance of quality growth stocks by identifying stocks with high quality scores based on three main fundamental variables: high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. The MSCI Quality Indexes complement existing MSCI Factor Indexes and can provide an effective diversification role in a portfolio of factor strategies.
• The MSCI EAFE Growth Index (Net MA Tax) is an unmanaged, market capitalization–weighted index of equity securities of companies domiciled in various countries. The index is designed to represent performance of developed stock markets outside the United States and Canada, and excludes certain market segments unavailable to U.S.-based investors. The growth investment style characteristics for index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate and long-term historical EPS growth trend and long-term historical sales per share growth trend. The index returns for periods after 1/1/1997 are adjusted for tax-withholding rates applicable to U.S.-based mutual funds organized as Massachusetts business trusts.
• Bloomberg Barclays U.S. Aggregate Bond Index is a market value–weighted index of investment-grade fixed rate debt issues, including government, corporate, asset–backed, & mortgage–backed securities, with maturities of one year or more.

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