Second Quarter 2020 Market and Economic Review
The first quarter of 2020 will be long remembered for the economic uncertainty, extreme volatility, and market decline triggered by the COVID-19 outbreak. Much more quietly, however, market returns of the second quarter have produced one of the best statistical quarters since 1998 primarily driven by the gradual reopening of the economy.
The S&P 500 index, which tracks the 500 largest public U.S companies, rose 20% over the quarter surpassing 3100 points for the first time since March 4th. As the economy reopened and earnings started to come in, stocks continued to rally, despite weak reports, as investors focused on earnings forecasts for Q3 and beyond in addition to the effects of quantitative easing. Furthermore, various drugs for a COVID-19 vaccine began making their way through clinical trials which spurred optimism in the market. Volatility has remained high, however, as record unemployment and worries of the economic impact of a second wave remain a major concern.
Small companies, as measured by the Russell 2000 Index, were some of the hardest hit economically during the first quarter. Having declined further in value initially, the Russell 2000 showed slightly better recovery than large companies with a 25% Q2 return. Smaller companies were aided tremendously through various government stimulus packages targeted directly at them and talks of additional packages on the horizon has allowed owners to retain employees and keep their doors open.
On theme, international markets have also improved with the MSCI EAFE, which captures data from 21 countries with developed markets, posting a positive Q2 rebound of 15%. Flare-ups of COVID-19 cases in various countries allowed volatility to remain present, yet an upward trajectory has been consistent throughout the quarter. Tensions between the US and China rose throughout the quarter, adding to the volatility, as mutual blame of the coronavirus pandemic continued to escalate.
The US bond market experienced the majority of its recovery over the last two weeks of Q1 largely due to the monetary policy actions of the Fed to buy back bonds. With the Fed stabilizing the bond market through quantitative easing and stating that they will continue to do whatever it takes moving forward to keep things stable, the Bloomberg Barclay’s Aggregate Bond Index has improved 2.9% for the quarter and 6.1% year-to-date. Treasuries posted the strongest returns, having less risk within the asset class, while riskier bonds such as emerging markets and high yield corporates are still showing negative returns on the year.
* Each benchmark is allocated based on assumed Risk Profile of underlying indexes.
**Benchmarks include a mixture of ICE BofAML US 3-month Treasury Bill Index, Barclays Global Aggregate Bond Index, Barclays US Aggregate Bond Index, Bloomberg Barclays Multiverse, Bloomberg Barclays Global High Yield, Bloomberg Barclays US Credit, MSCI EAFE Index, and the Value Line Composite Index (Geometric). These benchmarks are the same as those in the Risk/Return and Account Analytics sections of client quarterly performance reports. By comparing your portfolio’s return to the benchmark with the closest risk/return characteristics, you get a more accurate reading of portfolio performance than using a less diversified benchmark, such as the S&P 500 index.
Over the last three months, the increase in the market has been welcomed but some have questioned whether the markets accurately represent what is going on in the economy. Unemployment reached an all-time high with more than 16% of Americans filing for benefits in May. While the first-quarter GDP contracted at a negative 4.8% annual rate, the true impact of shutdowns won’t be fully reflected until the second-quarter GDP is announced on July 30th. Additionally, many cities, states, and businesses still aren’t operating at 100% while new cases of COVID-19 have started to spike. Though important, economic data like unemployment rates and GDP reveal what’s already happened, whereas the stock market anticipates conditions expected in the next six-to-nine months.
Leading economic indicators, on the other hand, are the data points that typically precede a new phase of the business cycle. Thus, as the economy looks to emerge from a massive halt in Q1, leading indicators are relied on heavily to predict a reversal or continuation of the trend. Fortunately, all five of the most commonly agreed upon leading indicators (interest rates, building permits, manufacturing jobs, durable goods, and the stock market) appear to have bottomed out at the end of Q1 and have regained upward trajectory which is why we’ve seen such a strong resurgence in the markets.
Following the Federal Reserve’s decision to cut interest rates to 0.25% in March, the Fed announced in early June their intentions to keep their benchmark interest rate near zero through 2022. While lower interest rates will help to encourage new business and growth, keeping money artificially cheap, along with quantitative easing, increases the risk of inflation in the long term. The yield curve remains flat between short and intermediate-term treasuries with a slight upward slope beyond 10 years.
Oil also had a historic quarter with the price of oil futures in April falling below $0 per barrel for the first time. This was triggered partly by the Russia-Saudi Arabia price war initiated in March. In addition, with the economy shut down, the supply of incoming oil was significantly larger than the demand, thus causing storage issues for new shipments. Though oil prices have remained lower, the reopening of the economy has played a role in the recovery of oil prices in the subsequent months.
International markets have also shown improvement economically despite tensions rising between the U.S and China. In addition to mutual blame over the handling of the current pandemic, China’s controversial national security law for Hong Kong has prompted Democrats and Republicans alike to speak out. This has resulted in the State Department declaring that Hong Kong could lose “significant autonomy” which will likely hurt its trade relations with the U.S.
The short-term unpredictability of the market, spurred on by both fear and optimism, has tested commitments to long-term plans. However, companies that provide needed services and produce earnings will thrive and survive in any market conditions. The Slaughter Investment Committee is focusing on those companies that will be around to experience those earnings and have created a business model with balance sheets to capitalize in this environment.
We will continue to monitor portfolios and make changes as appropriate. In the meantime, we wish and hope that all stay healthy and safe.