The first quarter was one for the history books. Stocks tanked -34% from their all-time high on February 19th through March 23rd, just before the end of the first quarter. One of the steepest drops in stock market history, and certainly the swiftest.
Well, the second quarter is also one for the history books. The past three months were almost a mirror image of the three months that preceded it. Stocks and other risky assets rocketed off their late-March lows.
Following the S&P 500’s first quarter loss of -20%, the index posted its largest quarterly gain in the second quarter since 1998, up 21%. The Nasdaq Composite and Russell 2000 surged 30.6% and 25%, respectively, over the past three months. Most of the second quarter's stock-market action took place in April and May. Major indexes have spent June in a relatively narrow trading range, as investors weighed increasing coronavirus cases against positive economic data. Year to date, the U.S. market is down only 3%, while small cap stocks (-13%) and foreign stocks trail U.S large company stocks.
The overall U.S. bond market is up 6.1% year-to-date, led only by treasuries 8.7% return due to falling interest rates. With the Fed reducing the overnight rate close to zero, the 10 year Treasury yield fell from 1.88% at the beginning of the year to around 0.7% now. Treasury inflation-protected bonds have returned 6% as inflation fears have surfaced due to the massive fiscal and monetary stimulus. Below-investment-grade bonds (junk bonds) are still in the red for the year.
The news today and every day is a tug of war between lagging economic indicators showing a rebounding global economy, while coronavirus cases and hospitalizations continue to rise in several U.S. states and regions abroad. In the past two weeks, state and local officials in the U.S. and abroad have paused or rolled back reopening plans, some businesses have voluntarily shut their stores, and consumers appear to be responding on their own by staying home and spending less in areas with growing outbreaks.
That comes after rapid progress on reopening the economy, and major rebounds in economic indicators from depressed levels in March and April. June consumer confidence increased significantly as American households remain more optimistic about the future than their current circumstances. Buoyed by massive fiscal support, consumer spending has been better than expected. Tellingly, the rebound in spending has been highest in the lowest quartile of earners demonstrating the influence of the package that has helped the economy through one of its darkest periods in modern history.
The unemployment rate for has been improving as June came in at 11.1% from the 13.3% in May and 14.7% in April. Still, the US labor market is operating with about 15 million fewer jobs than in February. The broader U6 unemployment rate, which includes persons marginally attached to the labor force and part-time workers who want full-time jobs, stands at 18% down from 21.2% last month, but a far cry from the single digits pre-COVID. Job gains in leisure and hospitality – a sector hard hit by the shutdowns – accounted for about 40% of June’s employment growth. Restaurants and bars were the main driver. But those workers are particularly vulnerable if re-openings are paused or rolled back. We are still very far from a healthy job market.
Enhanced unemployment insurance that puts an additional $600 in the pockets of those out of work each week is set to expire on July 31st. These payments, combined with a $1,200 check for those making less than $75,000 with an additional $500 for each child, were a key part of the first round of stimulus passed in March, a package that has helped the economy through one of its darkest periods in modern history.
The question on investors’ minds is whether these two opposing trends - spreading coronavirus versus an improving economy - can continue to exist at once, or if new outbreaks will materially impact progress on the reopening of the economy and delay its recovery. Another question for the markets is whether continued monetary input from the Fed will be sufficient to offset the apparent stalling, or even reversal, of the reopening of the economy. That’s in addition to the uncertainty over fiscal policies. On the federal level, another package totaling perhaps $1.5 trillion more might be agreed to soon. Stocks will lack a concrete near-term direction until an answer becomes clearer. And of course, there is the presidential election in November.
Depending on the day, news on any one of these fronts can send the market higher or lower
It might seem difficult to reconcile the disconnect between the huge rally, with the S&P 500 just 9% below record highs of February, and double digit unemployment and coronavirus infections surging across the South and West. But the massive stimulus provided by the Fed and fiscal policy from Washington is bolstering the markets. The historically low interest rates, (Fed funds at zero and 10 year Treasury note at around 0.7%) are offered by many as justification for high stock valuations. But low interest rates are also a warning that something is wrong. The Fed’s support of the corporate bond market has boosted stocks. But justifying stocks buoyant prices by ignoring the current profit collapse in favor of using 2021 or 2022 earnings expectations to calculate valuations recalls the valuation paradigms of past bubbles.
As Fed Chair Jerome Powell has often stated: the virus determines the shape of the recovery. Without successful containment of the coronavirus' spread there will not be a robust, extended economic rebound as current data are showing. There already are signs the economy could be affected by the virus surge that started in late June – after surveys for the jobs report were completed. Data from OpenTable, credit card spending, and foot traffic at retail locations show a noted slowdown in economic activity, while polling shows a recent uptick in consumer fears about contracting the virus.
Investors have been quite enthused about dynamics in the economy no longer getting worse. But not worse is a long way from good.
In the meantime, your portfolio is well diversified and invested in bonds and stocks that we firmly believe can weather this environment. We continue to follow a disciplined and rational plan to take us through the current and future environment.
Stay well and please let us know if you have any questions. We are always available to discuss your portfolio in detail. As always, we appreciate your valued trust in our services.
Thank you, Ben