A feeling of “what’s next?” is in the air. By now, Congress has gone home for the summer. Efforts to put more money in the pockets of tens of millions of unemployed Americans are stalled. Fall campaigning and mud-slinging have begun in earnest. Covid-19 rages on, a deadly whack-a-mole game played across the earth. Amid the uncertainty, July markets did well. But what can we read into the dollar’s decline and gold’s ascent? Let’s take a look.
July Market Report
Global stock markets continued to climb in July, extending their rally for the fourth consecutive month. The MSCI All Country World stock index returned 5.29%, further reducing its YTD decline and lifting its one-year return to positive 7.2% from negative -11.2% at the end of March.
US stocks as measured by the S&P 500 Index outperformed global stocks for the period, with a 5.64% return for July. The broad US index returned 2.38% YTD. The one-year return for the index rose to 11.96%, up from 7.51% at the close of June.
Among the major global equity categories, emerging market stocks, as measured by the MSCI EM Index, returned 8.94%, bringing the three-month return for the index to 17.84% and the one-year return to 6.55%.
On a consolidated basis, US and foreign developed stock markets returned 4.78%, or 2.66% ex the US. Within foreign developed markets, Pacific Rim stocks fell slightly, but excluding Japan they gained 2.56%. European stock markets rallied 3.84% in July.
As of July 31, the forward price-earnings ratio, based on earnings estimates for the current fiscal year, totaled 23.84 for the S&P 500, 18.57 for the MSCI World ex-USA Index and 15.84 for the MSCI Emerging Markets Index, according to Morningstar. Valuations for overseas investments are compelling for those with a longer-term horizon.
The dollar index made a sharp 10% reversal this summer following a long rally. The index, which measures the dollar against a basket of other major currencies, suffered its poorest monthly performance in 10 years, hitting the lowest point against its basket of peers since 2018.
The reversal that began in late March was no doubt spurred by worries that after a brief period of multistate curve flattening, growth in Coronavirus cases and US death rates will put the brakes on an economic rebound, even as growth accelerates in other countries around the world.
The dollar’s decline marks the end of a year-long climb that was fueled by bets that US economic growth would outpace activity overseas and enable the Federal Reserve to keep interest rates among the highest in the developed world. But now the Coronavirus is forcing the Central Bank to keep rates near zero, narrowing the gap between rates in the US and other nations, and limiting returns for investors who hold the currency. The US 10-year Treasury closed at 0.54%. The U.S. 30-year Treasury closed at 1.20%.
The Allure of Gold
Meanwhile, gold is king. With bond yields near zero in the United States and negative in Europe and Japan, the price of gold has climbed more than 30 percent in 2020 after gaining nearly 20 percent in 2019. It gained 11% in July alone. Ruchir Sharma of Morgan Stanley Investment Management notes one obvious reason: investors are betting that the mountains of money governments are pumping into their economies will ignite inflation.
But is gold a great investment? “Owing to its image as a stable store of value when other investments are shaky, gold has held up better than other commodities, but it still has not been a dynamic investment,” Sharma points out (NYT 8-August 2020). He notes that “Over the past century, the price of gold, adjusted for inflation, has risen by an average of just 1.1 percent a year, compared with 6.5 percent for US stocks. Even the 10-year US Treasury bond, considered the most risk-free asset in the world, has produced higher annual returns.” This may be disappointing news to gold bugs, who have pushed the price of gold to over $2000 an ounce for the first time. Nonetheless, this year, gold is the best performing traditional asset in the world.
Expectations of rising inflation are the necessary fuel for a continuing gold rally. “Anticipating higher inflation has been a losing bet for a large part of the last four decades, but the odds appear better now,” Sharma believes. “Most nations are doling out record levels of stimulus at a time when forces like globalization, which kept inflation in check, are weakening. Normally, if inflation looms, central banks can be relied on to raise interest rates, but Fed officials have signaled that they aren’t ‘thinking about raising rates,’ and do not expect to move before 2022."
His conclusion: "When interest rates are this low, money is virtually free, encouraging speculation in assets of no value to society, beyond what the seller can get for them. Gold is the prime example just now. The wider risk is that this kind of purely financial speculation undermines the economy by sucking capital away from industries that will put it to more productive use.”
A Very Mixed Picture
From the vantage point of a slow-to-act Washington and Wall Street, things seem fine enough, with continued improvement in the job market and the stock market climbing close to its all-time record high.
But the market’s complacency runs counter to the renewed rise in Covid-19 cases in much of the South and West. The Labor Department reports that the American economy slowed in July as the pace of hiring eased from the previous two months. Virus-related restrictions caused some businesses to close for a second time. The slow recovery and signs of backsliding also took a toll on consumer confidence, which fell in July after rising in June.
If there’s good news, it’s that the wave of evictions and foreclosures that many economists predicted early in the recession largely failed to materialize as a result of low interest rates and major support provided by Uncle Sam. This kicked the can down the road for managing the worst recessionary aspects of Covid-19. But governmental support programs have now expired, or are about to expire. Efforts to extend further aid were sidelined by disagreements in Congress—both among Republicans and between Republicans and Democrats—about how much to spend and where to spend it.
With some 30 million people receiving unemployment benefits, many economists predict that the expiration of aid will further stress the economy at a time when the virus remains a major threat and jobs are scarce.
In one ominous sign of what may be to come, the six biggest banks recently added some $36 billion to their reserves for future loan losses. This is not a normal recession, says JP Morgan Chase CEO Jamie Dimon, who warns that we will see the recessionary “part of this … down the road.” So despite the $3 trillion Cares Act, we are left with great uncertainty: major disagreements over how to help the unemployed, no clear signs of how or when people will go back to work en masse or when schools will re-open, and no clear understanding of how or when the virus will be controlled. These are all serious short-term concerns.
Investors would love clear direction, but that’s not what they’re getting right now. Despite the market’s strong recent performance, the waters are muddied. Without a doubt, an eventual recovery will take hold. Investors will be rewarded over time for taking risk, the same as always.
As we reminded you in our last blog, investors tend to harm their long-term prospects when trying to time the market. It’s fine to have opinions, hopes and fears. But if your portfolio is diversified and allocated according to your personal risk tolerance and long-term goals, your best option is to stay the course. As July demonstrated, the performance of the stock market has little to do with our moods and feelings.
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