Market Digest – March 2020 Positioning in a bear market Table of contents Executive Summary 2 Global Allocation 3-5 U.S. Stock Market 6-8 U.S. Sectors 9-10 Energy 11-12 Global Economics 13-15 U.S. Fixed Income 16-20 U.S. Economics 21-23 Ned’s Insights 24 AMY LUBAS, CFA, DIRECTOR, WEALTH Glossary of Terms 25-26 MANAGEMENT & ADVISORY SOLUTIONS House Views 27 CHAD ELLIS, RESEARCH ANALYST MARKET DIGEST SUMMARY AMY LUBAS, CFA DIRECTOR, WEALTH MANAGEMENT & ADVISORY SOLUTIONS CHAD ELLIS RESEARCH ANALYST MARCH 16, 2020 Executive Summary De-risked across the board How the current cyclical bear compares to previous bears Coronavirus (COVID-19) continues to domi- A History of Bear Markets II: Dow Jones Industrial Average (1900-Present) nate world news. Since last month’s update, the -10 Current bear 1953 Sources: S&P Dow Jones Indices 2016 virus’ rapid spread outside of China, announce- 1984 1971 1949 1980 Ned Davis Research Calculations 2011 1960 1923 ment as a pandemic, and increasing fears of an -20 20201998 1957 1990 19391934 1947 1982 1914 economic recession have rattled investors. All 1966 1962 1978 1911 -30 markets have taken a beating in March thus 2001 2002 far — we are officially in an NDR-defined bear 1987 1970 1933 -40 market. As such, we made several position 1917 1942 changes over the past couple of weeks. 1974 1921 1903 1929 -50 1938 1907 Loss % • On March 6, we de-risked in fixed 2009 income. We increased our duration -60 to 110% from 100%, as the demand for safe, long duration assets continues. In -70 Cyclical Bears Independent of Recessions light of recent market developments, we Mean for Cyclical Bears Independent of Recessions (-25.0% Loss, 200 Days) Cyclical Bears Coinciding with Recessions -80 downgraded investment grade credit, Mean for Cyclical Bears Coinciding with Recessions (-34.5% Loss, 369 Days) Mean for All Bear Markets (-30.9% Loss, 307 Days) CMBS, MBS, and ABS to underweight, Current Bear Market Days = market days 1932 joining our underweight on high-yield. 0 25 50 75 100 125 150 175 200 225 250 275 300 325 350 375 400 425 450 475 500 525 550 575 600 625 650 675 700 725 750 775 800 Market Days Treasurys are the beneficiaries at over- S0202D © Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html weight. For data vendor disclaimers refer to www.ndr.com/vendorinfo/ • On March 9, we moved to a bearish view on oil. An OPEC price war occur- thrusts (without an intervening thrust to Consumer Staples to overweight ring in the midst of a global demand the downside). and Real Estate to marketweight. With shock (i.e., the coronavirus outbreak) is • On March 12, we shifted 5% from many now expecting flat to down earn- completely unprecedented. We are in stocks to bonds in re sponse to model ings growth for the S&P 500, Consumer unchartered territory. and indicator deterioration. This move Staples’ mid-single-digit earnings growth • On March 10, we went cautious on brings us more in line with our Global should look superior. We also down- U.S. stocks, which means sub-par Balanced Account Model at 50% stocks graded Industrials, Financials, and returns. The market decline has met the (now underweight), 45% bonds (more Energy to underweight. NDR criteria for a cyclical bear mar- overweight), and 5% cash (under- ket. To date, the decline is smaller than weight). We are watching for indicator Economic impact the median bear (chart above), but developments that would be consistent Whether the hit to economic activity is clas- more importantly, it is the shortest on re- with a bottoming process or continued sified as recession or not will largely depend cord. Market bottoms are a process that weakness. on its duration. Recent monetary and fiscal take time. The four steps are: 1) oversold; • On March 13, we got more defensive policy announcements are trying to mitigate 2) rally; 3) retest; and 4) positive breadth in our U.S. sector allocation. We lifted the damage. PERIODICAL | ISSUE: #MKTDG20200316 | NDR.COM Please see important disclosures at the end of this report. MARCH 16, 2020 2 MARKET DIGEST GLOBAL ALLOCATION TIM HAYES, CMT CHIEF GLOBAL INVESTMENT STRATEGIST ANOOP NATH, CFA GLOBAL ANALYST MARCH 16, 2020 Volatility has returned, stocks downgraded After spiking, VIX tends to stay high VIX around Spikes over 30 Key Takeaways 55.0 Source: Chicago Board Options Exchange, Incorporated. www.cboe.com 55.0 Current Case (2020-02-27) 52.5 Average of All Cases* 52.5 * Based on the average of the 18 cases listed below going back to 1990. 50.0 Excludes current case. 50.0 • Shifted 5% from stocks to 47.5 47.5 bonds in response to model and 1990-08-06 2007-08-15 45.0 1997-10-27 2008-03-14 45.0 indicator deterioration. 1998-08-04 2008-09-15 42.5 1999-02-08 2009-05-21 42.5 2000-04-14 2010-05-06 40.0 2000-12-20 2011-08-04 40.0 • Now 5% underweight stocks and 2001-09-07 2015-08-24 37.5 2002-07-09 2018-02-05 37.5 10% overweight bonds at 50% 2003-01-24 2018-12-21 35.0 35.0 stocks, 45% bonds, and 5% cash 32.5 32.5 allocation. 30.0 30.0 27.5 27.5 • Watch for indicator developments 25.0 25.0 that would be consistent with a 22.5 22.5 bottoming process or continued 20.0 20.0 weakness. 17.5 17.5 15.0 15.0 12.5 12.5 Crosses above 30 for the first time in six months Just when it looked like the global stock -3 -2 -1 0 1 2 3 Months Prior | Months Post market advance would start to broaden INF20_10A_C © Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html — anticipating a strengthening economic For data vendor disclaimers refer to www.ndr.com/vendorinfo/ recovery — along came the coronavirus panic to knock it back down. And just stocks (5% underweight), 45% bonds likely an oversold bounce than the start when the indicator evidence had improved (10% overweight), and 5% cash (5% of a sustained recovery. On February 27, enough to warrant an allocation shift from underweight). the VIX reached a level that has tended bonds to stocks, along came the most to be followed by a median drawdown of decisive wave of indicator deterioration This move recognizes the magnitude of -19.4% in the All-Country World Index. The since 2018. the economic hit from the coronavirus current drop has been -19.7%, with volatility response and the time that will most remaining elevated. With our current intra-month estimate likely be required for economic conditions for the Global Balanced Account Model to improve — even if global cases of Rising above its Bottom Watch parameter showing the stock allocation dropping COVID-19 follow China’s trend and start to of 43, the VIX has reached levels last to 46% and the bond allocation rising subside. seen in 2009. While there’s no way of to 50% — with the remainder in cash — knowing how high the VIX will rise, history we shifted 5% from stocks to bonds It also recognizes that the market’s attempt suggests we won’t see a return to low on March 11. This brings the allocation to stabilize and turn higher has failed volatility any time soon (chart above). more in line with the model at 50% miserably, with the March 10 rebound more PERIODICAL | ISSUE: #MKTDG20200316 | NDR.COM Please see important disclosures at the end of this report. MARCH 16, 2020 3 MARKET DIGEST GLOBAL ALLOCATION 4 | NED DAVIS RESEARCH Until volatility subsides to such an extent Rising VIX, dropping yields and equities Daily Data 2010-03-11 to 2020-03-10 that a VIX downtrend is established, stocks One-Year Correlations- ACWI, VIX & 10-Year Treasury Yield 60 S&P 500 Volatility Index (VIX) (2020-03-10 = 47.3) Source: Chicago Board Options Exchange, Incorporated. www.cboe.com 60 should have trouble recovering, considering 50 50 the strong inverse correlation between the 40 40 30 30 VIX and the All Country World Index (ACWI) 20 20 (chart right, third clip). Given the inverse 10 10 10-Year Treasury Yield (2020-03-10 = 0.8%) correlation between the VIX and the 10-year 4.0 4.0 3.5 3.5 Treasury note yield (bottom clip), falling bond 3.0 3.0 2.5 2.5 yields can be expected with bouts of volatility. 2.0 2.0 1.5 1.5 1.0 1.0 0.5 Source: Federal Reserve Board 0.5 Source: MSCI When coronavirus worries start to subside -0.65 -0.65 and global economic activity starts returning -0.70 -0.70 to normal, we will likely see stock prices -0.75 -0.75 moving higher with rising bond yields and a -0.80 -0.80 -0.85 -0.85 falling VIX. But there’s not yet any evidence Rolling One-Year Correlation: Daily % Change of VIX & MSCI ACWI 2020-03-10 = -0.80 -0.1 -0.1 that such a recovery is at hand, hence -0.2 -0.2 our overweight allocation to bonds and -0.3 -0.3 -0.4 -0.4 underweight allocation to stocks. -0.5 -0.5 -0.6 -0.6 Rolling One-Year Correlation: Daily % Change of VIX & 10-Year Treasury Yield 2020-03-10 = -0.42 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 As long as stock volatility remains elevated, Data Range (Years): 1 2 5 10 Max high bond volatility can be expected to I87_CORR © Copyright 2020 Ned Davis Research, Inc.