Letter To Partners: A Choppy Second Quarter In Review

Letter To Partners: A Choppy Second Quarter In Review

Summary

Today, I would like to share with the Seeking Alpha community the second part of my letter to DM Martins Multi-Asset Fund’s partners.

The dichotomy between very fragile economic fundamentals and generous fiscal and monetary policy has created a unique dynamic in the markets.



A diversified approach and active risk management style should allow a portfolio to grow strongly over time while weathering storms better than a passive, stock-only portfolio could.

In addition to running DM Martins Research, I also manage DM Martins Multi-Asset Fund, L.P. This weekend, I forwarded my quarterly letter to the limited partners, discussing the portfolio’s performance in the second quarter of 2020 and presenting my observations about the markets and the economy.

Today, I would like to share with the Seeking Alpha community the second part of this letter — while, for compliance reasons, omitting any portfolio-specific information. I conclude this article with a few lessons learned during this eventful three-month period, and share some thoughts about what lies ahead (section not originally included in the quarterly letter).

Credit: Smart Asset

The Economy

To say that the global economy has been in distress as the COVID-19 crisis continues to unfold would be an understatement.

Although data has been contradictory and, at times, pointed in the direction of a strong rebound over the past several weeks, the key metrics used to measure the state of the economy clearly suggest that we are not out of the woods. From consumer spending and confidence to industrial output and employment, the second quarter of 2020 has fallen well short of last year’s levels.

The economic recovery has been happening, but slowly and off a deeply depressed March and April base that was distorted by widespread but temporary business shutdowns. Certain sectors and demographic groups have been suffering disproportionately more from the crisis, while a few others have even thrived in the current environment.

To combat the massive headwinds, federal governments and central banks have been stepping up to the plate. In the US, the Treasury department has filled most of the gap in household income, a move that is expected to push the budget deficit from unusually large in 2019 to highest ever in 2020.

On the other side of the fence, the Federal Reserve has assumed a key role in providing liquidity to the markets. It has expanded the reach of its quantitative easing program to include longer-term treasuries, bond funds and even individual corporate debt within the mandate. As a result, yields remained in check, and even so-called real assets like gold and real estate seem to have benefited from the lavish supply of capital.

The markets

The dichotomy between very fragile economic fundamentals and generous fiscal and monetary policy has created a unique dynamic in the markets. For starters, almost all major asset classes – from stocks (SPY) to bonds (TLT)(IEF) to gold (GLD) and commodities (DBC) – managed to finish the second quarter of 2020 higher and near peak levels, despite all the challenges.

Even more interestingly, rising asset prices have come alongside high levels of volatility, which is historically unusual. Case in point, the S&P 500 lost more than 5% of its value on a single day in June after being less than 5% off all-time highs earlier that same week. Something like it had only happened four times in post-Depression history, and not once since the dot-com bubble days.

The histogram below paints a similar picture. Even though investors have been counting down to a fresh peak in the S&P 500 index, the 30-day average volatility at the end of June 2020 remained remarkably elevated. In fact, equity prices have been more jittery recently than they were when Lehman Brothers collapsed, in 2008, and immediately following the attacks of 9/11.

Source: DM Martins Research

Because of this push-and-pull dynamic between bulls and bears, placing bold bets in the market as of late has been imprudent, in my view. While I continue to believe in the three pillars of a successful growth investment strategy – broad diversification, controlled use of leverage and low tolerance for sizable losses – a portfolio’s conservative profile in the second quarter seemed most appropriate, given the market landscape.

Lessons and final thoughts

  • For active investors, using a rules-based investment system that is agnostic to the portfolio manager’s personal convictions is probably the best approach. The market has behaved very erratically in the second quarter, and trying to second-guess its direction in the short term likely proved to be frustrating to most investors.
  • In my view, investing well is not a matter of shooting for the highest possible return. Instead, it is a two-pronged topic of conversation: (1) how much gains a portfolio can produce and (2) at what level of risk. Striking the right balance between these two mandates is key.
  • While I am highly skeptical of my ability to predict the future, I don’t expect the third quarter of 2020 to be a walk in the park. Aside from timing luck, I believe that well-balanced investment strategies will perform better, in risk-adjusted terms, than speculative bets in riskier assets (e.g. low valuation stocks (VTV), commercial real estate (VNQ), etc).
  • Whether stocks surge or falter going forward, I believe that a diversified approach and active risk management style should allow a portfolio to grow strongly over time while weathering storms better than a passive, stock-only portfolio could.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


Originally published on Seeking Alpha

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AbbVie Inc. 
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Smartsheet Inc. 
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Zai Lab Limited 
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NVIDIA Corporation 
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