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In the wake of 2020’s disastrous first quarter for income investors, this blog offered the following suggestion:
“Most of the Bloomberg Barclays U.S. Aggregate Bond Index is now either guaranteed by the full faith and credit of the U.S. government or backstopped by the Federal Reserve (Fed). Investors need significant exposure to these assets because they provide stability and protect against major drawdowns. But investors also need exposure to riskier asset classes to maximize risk-adjusted returns.”
Buoyed by expansionary monetary and fiscal policy, the securities markets saw a return to risk taking in the second quarter of 2020. Near-term liquidity concerns for the banking system and broader economy receded with the Fed backstopping a broad swath of mortgage-backed securities (MBS), municipal bonds, and corporate credits. On the fiscal side, stimulus payments and expanded unemployment benefits provided by the CARES Act pushed personal income up 10.5% in the month of April even as economic lockdowns reduced spending outlets and pushed consumer spending down by a record 13.6%. The result was an unprecedented personal savings rate of 33% in April.
With extra cash on hand, widespread joblessness and a lack of entertainment alternatives, many young people dipped their toes in the investing water for the first time. Robin Hood, an online trading platform popular with Millennials, saw its user base grow 30% to 13 million accounts in the first four months of the year. These investors largely eschewed ETFs, instead piling into speculative individual stocks. These included dubious issues like Hertz Global Holdings, Inc. (NYSE: HTZ), the bankrupt car rental business that became the first company to attempt to secure Chapter 11 debtor-in-possession financing through the sale of common stock. While that gambit failed after the Securities and Exchange Commission balked, HTZ continues to sport a $206 million dollar market cap even as most institutional analysts deem its equity worthless.
In an unlikely twist, the pied piper of the Robin Hood set turned out to be a gonzo sports journalist turned aspiring sports gambling magnate. At the start of the Covid-19 crisis Dave Portnoy, founder of online sports and culture blog Barstool, was just coming off the triumphant tie-up of his company with Penn National Gaming, Inc. (Nasdaq: PENN) in a deal that aspired to marry Barstool’s young and loyal fanbase to PENN’s online sports gambling aspirations. With no sports gambling picks to tout, Mr. Portnoy turned to the stock market, rechristened himself Davey Day Trader and began promoting his day trades to his millions of online followers. “I’m sure Warren Buffett is a great guy,” Mr. Portnoy noted of the legendary investor, “but when it comes to stocks he’s washed up.”
For his part, Mr. Buffett mostly sat on the sidelines with his massive pile of cash during the March crash and went so far as to liquidate his airline holdings, unusual for an investor who describes his preferred holding period as “forever.” Investors seemed unphased by Mr. Buffett’s liquidation sale, instead piling into a once-obscure airline ETF that became a favorite vehicle for those looking to bet on a return to economic normalcy. The U.S. Global Jets ETF (NYSE Arca: JETS) held $33 million of assets under management (AUM) on March 2, 2020 before beginning a 70-business-day streak of inflows that saw its AUM exceed $1.5 billion at one point before falling back to about $1.2 billion as of this writing.
For income investors, the second quarter of 2020 was about as good as it gets. The table below provides return data for major income-oriented asset categories for the period from April 1, 2020 through June 30, 2020.[1] Also included are returns for the Nasdaq 7HANDL Index, a multi-asset index of ETFs. Every income-oriented asset category earned positive returns during the quarter.
This blog closed its first quarter recap with some advice concerning some of the most beaten-down income-oriented asset categories:
“[S]tructural changes in the economy may prove challenging for asset categories like REITS and MLPs with exposure to sectors disproportionately impacted by the crisis. At the same time, they offer the potential to provide excess returns. Income investors need exposure to asset classes like this if they are to maximize risk-adjusted returns, but … they should do so as part of a well-diversified portfolio.”
Illustrating the importance of diversification, MLPs bounced back in the second quarter, trouncing every other income-oriented asset category on both an absolute and risk-adjusted[1] basis. REITs, on the other hand, continued to lag the broader equity market as lockdowns and work-from-home policies continued to pose an existential threat to the commercial real estate sector.
MBS was the worst performing income-oriented asset category on an absolute basis, while utilities performed the worst on a risk-adjusted basis. The Nasdaq 7HANDL Index, which incorporates all the income-oriented asset categories, returned 12.1% for the quarter.
Over the long run, the picture remains largely unchanged from what it looked like at the end of the first quarter. The table below provides return data for the same asset categories for the period from January 1, 2009 through June 30, 2020[2]. The highest total returns came from riskier asset categories, with core equity leading the pack. The highest risk-adjusted returns, however, were generated by the index of ETFs offering diversified exposure to all the asset categories.
Going forward, uncertainty in the real economy remains a concern with indicators sending mixed signals. While the prices of oil and copper, two popular barometers of economic activity, have recovered from crisis lows (with copper actually touching a 52-week high), some of this appreciation can be attributed to capex reductions by drillers and miners rather than renewed economic activity. Retail sales ex-gas reached an all-time high in June, benefitting from stimulus payments and enhanced unemployment benefits. But initial jobless claims appear to have stabilized at an alarmingly high level of more than one million per week and the travel, leisure and hospitality industries remain in desperate straits.
In the near term, the looming expiration of CARES Act enhanced unemployment benefits at the end of July poses the risk of renewed volatility in the securities markets during the third quarter. While valid questions remain as to the incentive effects of enhanced unemployment benefits, a failure to extend them would almost certainly deflate the risk-on rally. For a President who has staked his reputation on the stock market, this outcome seems unlikely.
In the long run, much depends upon humanity’s response to the COVID-19 virus. The holy grail, of course, remains the development of an effective vaccine. Robin Hood traders have busied themselves betting on the ultimate winner of the vaccine lottery, but the potential gains for the broader economy from an effective vaccine dwarf those of any potential vaccine profits and help explain why airlines and cruise line operators rally on any positive news regarding the development of a vaccine.
The alternative to a vaccine offers less promise, with businesses left to adapt to an extended period of social distancing that threatens to strand billions of dollars of capital in no-longer-productive assets. For income investors, the importance of a well-diversified portfolio that protects against large drawdowns remains as imperative as ever.
[1] Returns for each asset category are based on the returns of the constituent(s) in the Nasdaq 7HANDL Index representing that category.
[2] Risk-adjusted returns are calculated by dividing annualized return by annualized standard deviation.
[3] Active fixed income and MLPs are not included in this table because the underlying constituents did not exist on the start date.
