A Smarter Way to Invest Market Summary 6-4-2020
Provided By: Adam Blocki, CFA, CFP® – Senior Portfolio Manager
In March, a new bear market was ushered in; in April, the bull returned…technically. As a 20% drop from previous highs signals a fresh bear market, so does a 20% rise from previous lows signal a fresh bull market. After dropping as low as 2,191 in March, the S&P 500 surged as high as 2,954 in April marking a 34% gain from the March low, well past the 20% needed to establish a new bull market. Despite this action, it is almost the consensus view on Wall Street that we are far from out of the woods. The term “bear market rally” refers to a short-term recovery during a bear market that ultimately gives way to new lows. These are not an uncommon occurrence; the dotcom bubble and financial crisis both saw short-lived rallies that faded away. Given the uncertainty of our present situation, I don’t think that scenario is at all far-fetched this time around.
For now, however, the rally is on. All major equity indexes rose for the month of April. Domestic markets seemed especially robust with the S&P 500 (12.7%), S&P 400 (14.1%), S&P 600 (12.6%), NASDAQ Composite (15.4%), and Dow Jones Industrial Average (11.1%) all seeing double-digit gains while international developed markets (MSCI EAFE, 6.3%) and emerging markets (MSCI EM, 9.0%) lagged behind. All eleven GICS sectors rose with the much-maligned Energy sector leading the way (XLE, 30.8%) while Utilities (XLU, 3.3%) and Consumer Staples (XLP, 7.0%) brought up the rear. In the fixed-income world, US Treasuries (IEF, 0.2%) seemed to take a breather from their March rally while investment-grade corporate (VCIT, 4.9%), high yield corporate (HYG, 4.4%), and international bonds (IAGG, 1.5%) all picked up the slack. Finally, gold (GLD, 7.3%) surged on worldwide stimulus efforts. That gain was offset by continued pressure on oil prices that brought commodities as a whole (DJP, -1.8%) down for the month.
April’s rally seems, on its surface, to defy economic reality. However, it is important to keep in mind the forward-looking nature of the stock market1. The price of stocks today is a reflection of expectations for future profits. March’s respective 35% and 45% peak-to-trough drops in the large and small cap S&P indexes were reactions to the expected future hit to revenue from shut-downs. The April rebound is looking at future assumptions of what a return to normal means and deeming March’s reaction to be overly pessimistic.
This resiliency has shown itself in varying ways across asset classes. With fiscal stimulus, monetary stimulus, and calmer heads all entering the picture since March, we have seen winners and losers start to separate themselves. A wide gap has emerged between large and small-cap U.S. stocks. At the high point of the April rally, the S&P 500 Large Cap Index was 12.9% off of its 2020 high while the S&P 600 Small Cap Index was still down 22.6%. Given the trends that have emerged in recent jobless claims data, I would venture a guess that the smaller companies on Main Street are hurting even worse. It seems that larger companies with cash resources and access to credit have been judged to be more able to bridge a short-term revenue gap while smaller companies are viewed as being less resilient to the interruption. With the brunt of layoffs coming in the service and retail sectors, many local and family-owned businesses are likely being hit the hardest, leaving large corporations looking relatively stable. Tech companies that depend more on digital revenue have also held up relatively well with the NASDAQ Composite less than 9% off of its record high at April’s peak.
Conversely, our perspective from today’s vantage may prove to be overly optimistic. As sectors of the global economy begin to re-open in May, the market will again adjust its expectations in light of new information. April strength might give way to renewed May volatility if attempts at returning to normal activity lead to a spike in new infections and shut downs are subsequently re-enacted. Only time will tell if the worst is behind us or if additional waves of infection await. With increased testing capabilities and contact-tracing technologies, we could optimistically see future containment efforts that are more localized with minimal nation-wide impact, leading to stability in asset prices.
While we still don’t have a complete picture due to lagged data, April gave us a glimpse of how bad the damage to the economy has been. Jobless claims have continued to defy comparison with the last 6 weeks seeing 30.3 million people file new unemployment claims2 (the highest 6-week total during the financial crisis was 3.9 million). Our initial reading of first quarter GDP saw an annualized drop of 4.8%3 (the worst quarter since Q4 2008 at -8.4%) with a much worse number awaiting in the second quarter. Industrial production, durable goods orders, motor vehicle sales, and many other data points all showed precipitous drops as well. Most of these figures represent March data that only reflects the beginning of the true shut-down impact. The future likely holds even worse numbers that rival, and possibly eclipse, those seen during the Great Depression.
Despite this fact, the outcome may not be as bad as then at the personal level. In the 1930s the economy was still on the gold standard with the creation of new money tied to the supply of physical gold. Untethered from that restriction, the Federal Reserve is free to print money at will in an attempt to brunt the economic impact on companies and individuals. With fiscal and monetary stimulus freely flowing, references to “QE4ever” and memes featuring Fed Chairman Jerome Powell firing money cannons have entered the financial zeitgeist. As part of their effort to support fixed income markets, the Federal Reserve enlisted help from BlackRock4. The details of the arrangement disclose the fees that the asset management firm can earn from the partnership, the scope of which extends to bond ETFs. Some have opined that this also opens the door for future equity purchases if the need for additional stimulus led to that extreme scenario. While there will undoubtedly be a price to pay on the other side of this crisis for all of this additional spending, possibly in the form of higher taxes or fiscal austerity, it may also help us avoid the “bread-line” scenarios often associated with the Great Depression.
In the U.S., this fiscal stimulus has come in the form of direct payments to individuals, loans to small businesses, and support to local governments with calls for even further measures. Subsequently, some complaints have surfaced as direct payments have been insufficient for some, unnecessary for others, and in some cases intercepted by creditors; the fund for small business loans was depleted within days while some publicly traded companies and hedge funds maneuvered their way through the rules to access funds. The example of Denmark may show a more efficient path for stimulus efforts. Their government is offering to pay companies 75% of the salary for any employees that are not laid off5. This circumvents the necessity of small businesses applying for loans, prevents businesses and individuals who don’t need benefits from getting them, and ensures that most workers remain employed helping to restore both supply and demand when their economy is resuscitated.
At the outset of the pandemic, there were many people hoping for a V-shaped recovery that mirrored the speed and severity of the drop. The longer these shutdowns remain, the less likely that scenario is. Our dilemma right now is certainly a delicate balance between the health and safety of the American citizens versus that of the economy. As the economic slump continues, pent-up demand starts to become permanently destroyed; as more and more people become unemployed, the amount of friction preventing a return to normal increases. There comes a point where no amount of exuberant post-pandemic celebrating, and spending makes up for what has already been lost. Some have noticed signs of changing consumer habits emerging in the form of voluntary isolation even before official stay-at-home orders were enforced. There will likely be a similar level of trepidation once things slowly begin to reopen as the last two months of forced change weigh heavily on the minds of consumers worldwide6. The combination of reduced demand from the unemployed and reduced demand from those unwilling to put themselves and their loved ones at risk could lead to a prolonged recovery. The discovery and wide-spread distribution of a vaccine would likely lead to a collective sigh of relief from most, but the possibility also exists of lingering effects similar to those experienced after the Great Depression when personal savings rates significantly increased and reliance on borrowing dropped.
What we can be almost certain of is that some things will change for good. Supply chains will likely be revamped; the costs of pandemic-related regional shutdowns were unlikely to be a large factor in previous decisions but will now get increased attention. Foreign ownership of companies will also be more widely scrutinized. While this issue was already being more closely inspected in recent years, this will only increase as the pandemic has highlighted the importance of controlling access to critical goods in times of spiking demand. Production of goods may move closer to where they are ultimately consumed as countries prioritize satisfying local over foreign demand. As an example, 3M, a U.S.-based company with manufacturing operations in China, had trouble getting N95 masks to their home country when Chinese officials blocked export efforts, citing local demand7. PerkinElmer had similar problems getting test kits shipped to the U.S.
In a positive spin, companies are discovering their ability to quickly pivot. Shoe companies have switched to making protective masks8, breweries have begun producing hand sanitizer9, and car companies have pitched in to manufacture respirators10. The role of government in our lives may also be questioned as things that were unthinkable only two months ago such as universal basic income is suddenly front of mind for some politicians11.
Adam Blocki, CFA, CFP®
Sr. Portfolio Manager