Blink and you missed it

An investor finally opening up their account statement on June 8 would be forgiven for assuming it has been a quiet year in the markets. The S&P 500’s virtually flat performance on the year masks a wild ride, which can be broken into three parts. From January 1 through February 19 the S&P 500 continued its 2019 momentum, gaining 5.1%. That narrative quickly changed as Covid-19 fears gripped the market and the index quickly declined a massive 34% in the 23 trading days between February 20 and March 23. Swift and highly stimulative monetary and later fiscal policy has helped the index increase 45% since the lows of mid-March. This rally has caused the stock market to a level broadly the same as where it started the year.

S&P 500

SP 500 as of 6-7-2020

Source: Bloomberg LP

The flat market is even harder to square with the deep economic and earnings contraction the US and the rest of the world is currently experiencing.  Approximately 15 million more people are unemployed at the end of May relative to the end of February, a number undoubtedly understated due to workers dropping out of the labor force and data collection issues.  Analysts’ estimates for 2020 S&P 500 earnings have been slashed about 30%.  We could cite the negative economic data for pages.

So what has sparked this most recent rally?  We believe there are two powerful forces at work boosting stock markets and risk assets more broadly.  First, the massive fiscal and monetary stimulus has worked to soothe doomsday fears, firm the economy and inject confidence into markets.  The second factor is that reopening and virus developments have been quite positive relative to expectations at the depths of the market selloff.

Personal income YoY change (%)

Personal income YoY changes

Source: Bloomberg LP, Bureau of Economic Analysis

Policymakers have thus far provided a sturdy bridge for the US economy to traverse the steep economic cliff posed by Covid-19.   Through generous unemployment benefits, lending programs for small businesses and a slew of other programs, the stimulative policy have kept the sudden economic contraction contained and perhaps lessened the long-term damage.  For example, while the unemployment rate has spiked to the highest levels since the Great Depression at the same time personal income has increased over 11% year-over-year due to government checks and more generous unemployment benefits.

The stimulative policy – though targeted at the real economy – has also been an important driver of markets.  The Fed has targeted the credit markets in order to allow companies to roll over debt and finance themselves while activity grinds to a halt.  This action reduces bankruptcy risk significantly.  Longer term, the debate in the market has focused on whether the Fed and Congress will always forcefully step in whenever something bad happens.  If tail risk is off-the-table due to swift policy intervention, maybe a new paradigm is required for valuing stocks. 

The last driver of markets has been the relatively positive news on Covid-19 and the reopening process.  Some of the early states to reopen such as Texas and Georgia have not experienced a spike in new cases, an outcome very much in doubt just a few weeks ago.  Testing capacity has also increased rapidly with the US expanding its testing capacity about 60% in the month of May alone.  On the vaccine front we have had positive initial results from the Oxford vaccine and a slew of other potential candidates.  While the virus news will continue to be noisy, thus far the worst fears of a large-scale second wave have yet to materialize for a variety of reasons both known and unknown.

Going forward we remain modestly positive on equities, with a bias toward the US.  It’s very hard to make a positive case for equities based upon valuation alone with the forward S&P 500 Price-to-Earnings ratio currently at over 25x.  But times such as these require a more holistic view of markets not anchored to merely valuations.  Policy will remain highly stimulative for the foreseeable future as the US labor market takes quarters and likely years to fully heal.  The Fed in particular has made it quite clear that their toolkit is far from bare and they will undertake whatever actions necessary to keep the US economy on track. 

Our bullishness is tempered by an undoubtedly cloudy economic outlook.  The virus could very well return in the fall – or earlier – causing a halt to the reopening momentum.  The scars from the Covid-19 recession will not heal immediately.  Estimates indicate that even if all of the furloughed workers returned to work the unemployment rate would still be 7%, substantially above the pre-Covid rate of 3.5%.

While we are surprised by the strength of this rally, we do still see enough positive dynamics on the horizon to keep our risk-on stance.

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This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This presentation may contain forward-looking statements. “Forward-looking statements,” can be identified by the use of forward-looking terminology such as “may”, “should”, “expect”, “anticipate”, “outlook”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof, or variations thereon, or other comparable terminology. Investors are cautioned not to place undue reliance on such statements, as actual results could differ materially due to various risks and uncertainties. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested.

S&P 500 Index® is an unmanaged index of large-cap common stocks. Investments cannot be made in an index.

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