A couple of quotes from our previous report:
“Crazy times, unprecedented times, and you are prepared:
You just witnessed the fastest 30% decline from a recent high on record for the S&P 500 – in only 30 days. We have experienced historic volatility. No one likes bear markets and red flashing across the screen, but we have prepared for this.
More money is lost from irrational investors looking for short-term profits or being scared out during difficult times than is ever lost in the stock market by long-term investors… Having someone else to lean on and work with during times like this is so important.”
Second Quarter 2020 Key Takeaways
As fast as they dropped, financial markets seemed to defy grim economic news as investors looked past the current negativity toward a brighter future. Global equities performed strongly for the quarter. The S&P 500 Index gained an incredible 21%, and as of June 30 it’s now down only 3% for the year. Developed international and emerging-market (EM) stocks gained 17% and 19%, respectively, and outperformed U.S. stocks in late May and June.
Enormous levels of money printing and government spending certainly helped the mood of investors. Central banks around the world provided unprecedented support to markets and economies. On the fiscal side in the United States, trillions in direct payments and loans have been delivered to impacted citizens and businesses. The level of stimulus globally has already far surpassed what was issued during the 2008 financial crisis.
Short-term interest rates are now near zero or negative in most of the developed world. The 10-year Treasury yield fell slightly this quarter but has revolved around 0.7% for some time. (Unfortunately, we are finally getting used to earning next to nothing on our safe money.)
While markets have rebounded, we should continue to be ready for a potential double-dip – although probably not back down to the late-March market lows. This could be caused by disappointing developments on the virus/medical front. There are also other uncertainties surrounding the November election and the ongoing U.S.-China dispute that could disrupt financial markets.
We hold a more optimistic view. We would prefer to bet that “good old American ingenuity” will find solutions. If we continue to make steady progress with medical solutions, there is a good chance we will get a sustainable, albeit uneven, global economic recovery. Low interest rates, monetary and fiscal policy responses are providing all the fuel needed to move investments higher.
Second Quarter 2020 Investment Letter
For most of the second quarter, financial markets seemed to defy grim economic news, the continued spread of COVID-19, and worldwide protests against racial inequality. Global equities performed strongly for the quarter and rewarded investors who remained invested. From the March 23 low, the U.S. equity market soared 40%, recording its best return ever over any 50-day period.
Enormous levels of money printing and government spending certainly helped the mood of investors. Central banks around the world provided unprecedented support to markets and economies. On the fiscal side in the United States, trillions in direct payments and loans have been or are going to be delivered to impacted citizens and businesses. The level of stimulus globally has already far surpassed what was issued during the 2008 financial crisis.
In 2008 a major concern of ours was that excessive government spending would trigger high inflation. This never happened. The government took notice and this time came out with all guns blazing, banking that the real enemy would be a deflationary depression environment. Does government debt matter? Are there no consequences to printing with reckless abandon? Will we continue to struggle with low interest rates and low inflation? Justifiably we still have concerns but also realize stocks and real estate play important hedges against inflation. For the first time in my career, we are considering adding some gold to portfolios.
Second Quarter Market Recap
In the second quarter, larger-cap U.S. stocks gained 21% and smaller-cap stocks climbed 25%. Despite the medical, economic, and social turmoil all around, the U.S. market is down just 3% year to date (as of June 30) and only 8% below its all-time high on February 19.
However, there are distinct winners and losers beneath the surface: The Russell 1000 Growth Index is up 10% on the year, while its Value sibling is down 16%. That is a stunning 26-percentage-point difference. Or, from another angle, the S&P 500 technology sector is up 12% on the year, while the financials, industrials, and energy sectors are down 24%, 14%, and 35%, respectively. Once again diversification seems to be at odds with hitting a home run.
Looking overseas, developed international stocks rose 17% and EM stocks gained 19% in the second quarter. For the year, they are down 11% and 10%, respectively. As in the United States, growth indexes are meaningfully outperforming value indexes overseas.
Finally, in the fixed-income markets, core bonds gained almost 3% for the quarter as Treasury yields dropped slightly (falling bond yields imply rising bond prices) and investment-grade corporate bond spreads narrowed, rallying along with the equity markets. Riskier credit-sensitive sectors within the fixed-income universe posted very strong gains, making up for some of the ground from their first quarter losses. Floating-rate loans and high-yield bonds gained nearly 10%, leaving them around 5% underwater for the year.
Second Quarter Portfolio Performance & Key Performance Drivers
The incredible rebound in risk-asset markets – stocks, corporate bonds, and other credit markets – in the second quarter provided a strong tailwind for our portfolios.
We rebalanced portfolios mid-quarter which resulted in buying stocks while they were down.
We do not rule out the possibility that U.S. stocks could decline from their current optimistic levels, but we do not believe we will revisit their March lows (2,237 on the S&P 500). In the meantime, we are comfortable with current portfolio positioning, which balances a variety of shorter-term risks against attractive medium- to longer-term return opportunities, across a range of macroeconomic scenarios and potential market outcomes.
As highlighted above, global equities performed strongly for the quarter. While the U.S. market was the best performer, foreign markets gained momentum, outperforming the S&P 500 from late May to quarter-end. Overseas stocks continued to be more reasonably priced and could perform better as European responses to the virus have been relatively successful in comparison to the U.S.
Real estate has been reported in the news as a high-risk investment, but we point to the fact that most all your real estate is invested in apartments and industrial sectors. These have been the strong spots as opposed to the weaker retail and office sectors that continue to be reported and highlighted.
So where does this leave us? The successful containment of COVID-19 is not a foregone conclusion. The resurgence of cases in the southern and western United States, not to mention in several EM countries such as Brazil and India, is concerning. Local U.S. authorities have so far refrained from large-scale rollbacks of their reopening efforts. But if strict, widespread lockdowns return, the global economic recovery will be more drawn out, which would be a negative surprise for markets. There are also significant uncertainties surrounding the November election and the ongoing U.S.-China dispute that could disrupt financial markets.
However, we hold a cautiously optimistic view that with the recent uptick in COVID-19 cases, the overall social policy response will not need to be as draconian. Therefore, the economic impact should be less extreme than during the first wave. If a more benign public health scenario plays out against a backdrop of extremely loose fiscal and monetary policy, there is a good chance we’ll get a sustainable, albeit uneven, global economic recovery. It is unlikely to be a sharp V-shaped recovery, but something more gradual, with fits and starts along the way and with some sectors and industries doing much better than others. If so, corporate earnings are likely to rebound as well.
If you have concerns that the market has come back too quickly, consider that in an environment with very low interest rates and with fears of severe recession (or a depression) off the table, our economy will fully recover within a year. Investors are currently discounting the immediate and obvious negatives and are looking toward positioning their portfolio bets on the future. Like most times historically, if you wait for an all clear sign before investing, you will be too late.
It is probable that we will witness a rotation where value investing takes the leadership reins from growth stocks. Our portfolios are positioned to benefit from this change in leadership.
As always, it is paramount for our investment management to be guided by a strategy that meets the risk/return profile of the clients we serve. Also, we need to keep a long-term perspective with an eye on near-term risks so that we remain disciplined through the inevitable downdrafts that occur when fear in the markets is palpable.
In closing, if you know of any friends, coworkers or acquaintances that would benefit from our services and advice, please help them make a connection with us.
As always, we appreciate your confidence and trust in us.
Ron Dickinson, CPA, CFP®, MPA-Tax
[Financial Planning and Investment Management Services offered through Dickinson Investment Advisors, Registered Investment Advisor. Statistics and market information provided by Litman Gregory Advisor Intelligence.]