After Six Months, It’s Back to Earth
Plus June 2020 Market Report

If you had lived on a mountaintop for the first six months of 2020, unaware of all the tumult below, you may have concluded that nothing much happened to move the markets while you were gone. By the end of June 2020, the S&P 500 Index was down just slightly from where it began the year. This sanguine performance came despite scenes of death, destruction, isolation, outrage and fear that have rarely been witnessed on such a global scale. We offer our Q2 wrap-up and perspective here.

The last six months have felt more like six years for many investors. We kicked the year off with a presidential impeachment trial, quickly followed by the devastating coronavirus pandemic, nationwide shutdown and sharp economic downturn. We watched video of police officers killing people of color. We heard a US President threaten military action against US citizens. Meanwhile the relentless death toll of Covid-19 marched higher. The fact that stocks got pummeled in March made sense. That they didn’t stay depressed is causing investors to feel both relieved and concerned.

The swing was shocking no matter how you interpreted it. During the first six months of the year, stocks experienced their biggest quarter-to-quarter swing in more than 80 years, diving 35% in 23 days. But then came hope in the form of $1.6 trillion government stimulus package. This not only stopped the sell-off but sent the S&P 500 Index soaring by nearly 20%, its best quarterly performance since 1998.

Glass Half-Full or Glass Half-Empty?

Investors have much to digest right now, and both bulls and bears have compelling narratives.

From a global perspective, traders have either willfully ignored the economic devastation of the coronavirus or had the good sense to focus on the earnings flow once the pandemic ends. The International Monetary Fund’s (IMF) World Economic Outlook Update for June is gloomy in the short-term but expects that Q2 2020 will mark the bottom of the Covid-19 economic crisis. The IMF forecasts global growth of negative -4.9% this year and positive 5.4% for next year, with global output expected to slightly exceed 2019 levels by 2021.

That sounds encouraging. But there are plenty of market-watchers who envision a bleaker future with more volatility ahead. The recovery could be painfully slow and drawn-out; two steps forward, one step back. And prices have been driven up so fast that the stage now may be set for another correction. With the surge in Covid-19 cases at home and abroad, how many countries and companies will be able to effectively manage their bottom line?

One justification for higher equity valuations has been the dramatic drop in long-term government and corporate bond yields, which lifts the value of future cash flows via a lower discount rate. The Fed is forcing investors into equities, say some analysts. But what will happen if there are nasty shocks this earnings season? If confidence in a V-shaped recovery for profits is shattered, share prices would be especially vulnerable.

The potential for widespread bankruptcies and their impact on the economy is another concern. While many central governments look for safe and fast ways to reopen the economy, businesses generally seem inclined to take a more cautious approach. Bankruptcy filings in the US are rising at the fastest pace since 2013. A total of 3,427 companies filed for Chapter 11 bankruptcy by the end of the second quarter and a second wave is anticipated as tens of thousands of companies teeter on the edge.

In the capital markets, the number of companies that have defaulted on their debt through the end of the second quarter has already surpassed the total for all of 2019, according to S&P Global Ratings. The tally of 119 defaults worldwide was led by the US with a total of 78. Continuing this course would push the number of 2020 defaults as high as numbers experienced in 2009. 

So far, non-payments have been largely contained to certain badly affected segments including airlines, the hospitality industry, retail stores, cruise ships and others. But there’s a lingering sense that the worst has been only temporarily skirted. Some analysts warn that investors should brace for non-payments to spread beyond the most vulnerable industries and borrowers, thereby dragging asset prices lower across the board. High-yield issuers are under particular pressure.

Long-Term Investors: Don’t Fear a Recession

Many economists say a recession is inevitable, if it hasn’t already begun. This will tempt investors to abandon equities and move to cash. Yet equities have a history of positive performance in the two years that follow the onset of a recession. DFA research has shown that investors were rewarded for sticking with stocks over the past century, which included 15 US recessions.

Recessions understandably trigger worries over how markets might perform in the future. Some of these worries are justified, but many things that we conjecture will never materialize. The economy will eventually heal. Corporate profits will recover. Effective Covid-19 treatments including a vaccine will be found. That’s fine, you may think, but there are very real scenarios to consider. What about the effects of all that stimulus money? What about another correction? What about inflation? These are all unknowns. It is always risky to rebuild your portfolio based on unknowns. It is dangerous to time the market, even when one fears losses or avidly wishes to avoid risk.

The biggest risk in trying to time the market is inadvertently creating a portfolio structure that may accurately reflect one’s comfort level, yet is not the best asset allocation for realizing one’s financial goals. This sets up investors for subpar returns because they may miss important turning points in stock prices. It’s fine to have opinions, hopes and fears. It’s fine to feel encouraged on some days and deeply discouraged on others. But actively trying to time the market is a gamble without an expected payoff.

Do you have questions or concerns about your portfolio? Call me, I am here to help.

Q2 2020 Market Report

The coronavirus sent crude oil prices on a wild six-month ride. Oil started the year trading above $60 a barrel. The pandemic and ensuing global economic shutdown slammed U.S. crude; it fell below $0 for the first time ever in late April. Within weeks, though, prices had recovered. They ended the quarter around $40 a barrel.

Gold prices rallied 13% in the second quarter to close above $1,800 per ounce in their biggest quarterly advance since early 2016, with uncertainty about the economic recovery lifting demand.

The US dollar mirrored the swings in the stock market following the March selloff. At the peak of the arch selloff, the dollar strengthened to its highest level in three years, while the S&P 500 dropped to its lowest since December 2016. Since then, stocks have rallied and the dollar has weakened.

Corporate bond markets seized up in March. As fears of an economic depression sparked panic-selling, investors dumped their safest bonds to raise cash and triggered a spike in yields. The Fed turned the tide when it announced a program to buy Treasuries and investment-grade bonds, which it later expanded to include investment-grade and high-yield exchange-traded funds and some junk-rated bonds. The program flooded the financial system with desperately needed funds. Treasuries rallied and yields of investment-grade bonds dropped from their peak 4.58% on March 20, to about 2.75% a month later, close to levels in late February. This is the second time in just over a decade that the Fed has mobilized the full force of its balance sheet to put a floor under badly shaking credit markets. While the unprecedented level of stimulus measures helped to support liquidity and stabilize the near-term economic outlook for credit, ongoing uncertainty and weak credit conditions have led to underperformance in corporate bonds.

For bond investors, the risk is always of a sudden jump in yields driven by either accelerating inflation expectations or widening spreads (a price drop) in corporate bonds. Given the massive amount of stimulus measures offered in the recent months, inflation could be a concern over the next year as the economic recovery gains steam. A moderate steepening of the yield curve with short-term rates remaining low and long-term rates rising would drive a selloff in Treasury bonds that have been among the biggest winners in 2020, up over 20% YTD.

World Asset Classes

Equity markets around the globe posted positive returns in the second quarter. Looking at broad market indices, US equities outperformed non-US developed markets and emerging markets. Value stocks underperformed growth stocks, and small caps outperformed large caps. REIT indices underperformed equity market indices in both the US and non-US developed markets. [1]

US Stocks (57% of Total Market)

The US equity market posted positive returns for the quarter, outperforming non-US developed markets and emerging markets. Value underperformed growth in the US across large and small cap stocks. Small caps outperformed large caps in the US. REIT indices underperformed equity market indices.

International Developed Stocks (31% of Total Market)

Developed markets outside the US underperformed both the US equity market and emerging markets equities for the quarter. Small caps outperformed large caps in non-US developed markets. Value underperformed growth across large and small cap stocks.

Emerging Markets Stocks (12% of Total Market)

Emerging markets underperformed the US equity market but outperformed developed ex US equities for the quarter. Value stocks underperformed growth stocks. Small caps outperformed large caps. 

Real Estate Investment Trusts (REITs)

US real estate investment trusts underperformed non-US REITs in US dollar terms during the quarter.

Commodities

The Bloomberg Commodity Index Total Return returned 5.08% for the second quarter. Unleaded gas and Brent crude oil were the best performers, returning 69.46% and 31.26%, respectively. Lean hogs and coffee were the worst performers, declining 23.90% and 17.78%, respectively.

Fixed Income

Interest rate changes were mixed in the US Treasury fixed income market in the second quarter. The yield on the 5-Year US Treasury Note decreased by 8 basis points (bps), ending at 0.29%. The yield on the 10-year note decreased by 4 bps to 0.66%. The 30-Year US Treasury Bond yield increased by 6 bps to 1.41%.

On the short end of the curve, the 1-Month T-bill yield rose by 8 bps to 0.13%, while the 1-year T-bill yield fell by 1 bp to 0.16%. The 2-year note finished at 0.16% after a yield decrease of 7 bps.

In terms of total returns, short-term corporate bonds returned 5.59% for the quarter. Intermediate corporates returned 7.63%. The total return for short-term municipal bonds was 2.38%, while intermediate-term muni bonds returned 3.19%. General obligation bonds outperformed revenue bonds.

Global Fixed Income

Changes in government bond interest rates in the global developed markets were mixed for the quarter. Longer-term bonds generally outperformed shorter-term bonds in global developed markets. Short- and intermediate-term nominal interest rates were negative in Japan, while all maturities finished the quarter negative in Germany.

Impact of Diversification

These portfolios illustrate the performance of different global stock/bond mixes and highlight the benefits of diversification. Mixes with larger allocations to stocks are considered riskier but have higher expected returns over time. [2]

1. Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. The S&P data is provided by Standard & Poor's Index Services Group. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2020, all rights reserved. Dow Jones data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Bloomberg Barclays data provided by Bloomberg. Treasury bills © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).

2. STDEV (standard deviation) is a measure of the variation or dispersion of a set of data points. Standard deviations are often used to quantify the historical return volatility of a security or portfolio. Diversification does not eliminate the risk of market loss. Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management of an actual portfolio. Asset allocations and the hypothetical index portfolio returns are for illustrative purposes only and do not represent actual performance. Global Stocks represented by MSCI All Country World Index (gross div.) and Treasury Bills represented by US One-Month Treasury Bills. Globally diversified allocations rebalanced monthly, no withdrawals. Data © MSCI 2020, all rights reserved. Treasury bills © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).

Regards,

John Gorlow
President

Cardiff Park Advisors
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jgorlow@cardiffpark.com