The Quarter in Review | 2Q 2020

WE’RE AT HALFTIME – AND IT’S BEEN AN UNFORGETTABLE START TO 2020. After a record drawdown in the first quarter and a record rebound in the second quarter, the first half of 2020 certainly has been a memorable one in many different ways. Regardless of whether it was health-related concerns with the virus, record unemployment, bankruptcies, unprecedented government assistance across the globe, social distancing from friends and family, schools closing for the year, or sports seasons ending abruptly or never even starting – all areas of our lives seemed to be impacted.

SECOND QUARTER RETURNS. As life began to moderately stabilize in the second quarter with restaurants, retail stores and travel starting to open back up, stocks rallied hard. U.S. markets were up approximately +22 percent for the quarter, which is up +30 percent from the market low reached in late March. 

International Developed and Emerging Markets also experienced significant recoveries, up +15.3 and +18.1 percent respectively.  From an international perspective, this was a very broad rally. Returns were positive in all 25 largest Developed and Emerging Market countries.

A globally diversified portfolio of 50/50 equities and fixed income was up 9.5 percent for the quarter but still down -2.34 percent year to date.

FIXED INCOME. Interest rate changes were mixed in the U.S. as the Federal Reserve (Fed) had already cut rates to a range of 0 percent - 0.25 percent. In terms of total returns, short-term corporate bonds returned +5.59 percent for the quarter; intermediate corporates +7.63 percent, and intermediate-term municipal +3.19 percent. The broad aggregate bond index was up +2.90 percent for the quarter and +6.14 percent year-to-date.

ALTERNATIVE INVESTMENTS. Real Estate Investment Trusts (REITs) were one of hardest hit asset classes in the first quarter. Even with a 10 percent recovery, the U.S. REIT index is still down -22 percent on a year to date basis as expectations for delinquencies and outright defaults is high. The Bloomberg Commodity Index experienced a very modest recovery, up only +5 percent for the period after dropping over -20 percent in the first quarter. 

SUMMARY / LOOKING FORWARD           

When it comes to the relationship between economic data and stock market behavior, “better or worse” tends to matter more in the short term than “good or bad”; what happens on the margins is important. So even though stocks rallied 30 percent from the market low reached in late March, caution is warranted.

A healthy rally is one with broad participation. The current rally is very narrow, heavily dependent on less than 2 percent of the stocks in the S&P500. This means the overall performance of the S&P 500 is not representative of the market as a whole and that the index performance hinges on a very small group of stocks. Seven technology based stocks (Apple, Microsoft, Facebook, Google, Amazon, Nvidia and Tesla) make up approximately 30 percent of the S&P500 market capitalization and have been the driver behind the index returns. As of this week, the S&P500 Index on a year to date basis was down around 1 percent.  Without the seven aforementioned stocks it would be down 10.5 percent. To further the point, the equal weighted S&P500 Index (all stocks weighted equally not by market cap) is at the same level today as January 2018, the NYSE composite the same level as September 2017 and the Russell2000 (small company index) is at the same level it was at in July 2017.

The last time there was this much concentration in a few stocks within the index was 20 years ago back in 2000 right before the so-called dot-com bubble.  Microsoft, GE, Intel, Cisco and Walmart were the big heavies at that time making up approximately 20 percent of the market index, so less than the 30 percent today. Unfortunately, we all remember how that turned out. Intel, Cisco and GE have never recovered back to those valuations. No one would argue the current headline companies are not great businesses. The question is one of valuation and market concentration. As it relates to the market, the maxim “the past does not repeat itself, but it rhymes” in our opinion applies to current valuations. 

In late March, Congress passed Coronavirus Aid, Relief, and Economic Security (CARES) Act, providing $2 trillion of stimulus to individuals, families, workers, hospitals and both large and small businesses.  Unlike previous stimulus packages which were targeted at large corporations and the markets, this one also focused on helping individuals and small businesses weather the storm.

In addition, the Fed began a massive lending and asset purchase program in the second quarter which helped to prop up the fixed income markets. As part of this, they reduced regulations on banks to free up excess reserve capital for lending. The Fed also started purchasing assets they have not previously bought before – specifically non-investment grade debt (junk bonds) and exchanged traded funds (ETFs). For example, they are now the third largest holder ($1.8 billion) of iShares Investment Grade Corporate Bond ETF (LQD) and own 20 percent of Vanguard Short Term Corporate Bond (VCSH). Unlike individual securities that the Fed has historically held that organically roll off their balance sheet based on stated maturities; when the Fed begins to sell off these ETF holdings it could cause significant disruption in that asset class.

Will these initiatives be enough to “bridge” individuals, families and businesses from the intense initial impact of the virus to a season of greater economic stability? 

We have to keep in mind, these actions were not investments to grow the economy but more to keep it from possibly teetering on the verge of an economic depression.  Never in any time in our history has so many things been shut down, closed or canceled with great uncertainty about when or even if they will open back up.

From an employment standpoint, more than 52 million Americans filed for unemployment over a four-month period. There are still in excess of 33 million workers receiving jobless benefits, this compares to 2.1 million in the middle of March.

As consumers cut back their purchases to mostly essentials, the personal savings rate which had been hovering around 8 percent rose to over 30 percent. Hopefully this will translate into pent up demand in the months ahead if the job market continues to recover. 

As we outlined last quarter, companies that persevere through this season we believe will come out stronger and much better positioned. Many businesses took the opportunity of low rates to shore up their balance sheets through issuance of new debt, year to date over $1.15 trillion of new debt was issued by investment-grade rated companies. They also were forced to rapidly re-examine how they do business – streamlining operations, rationalizing costs and revamping supply chains. Technology initiatives to work remotely were accelerated, leading to great efficiencies.

We are hopeful and optimistic about what the future will bring while also remaining realistic. We do not expect the recovery to be in a straight line but with fits and starts along the way, so our word for this season is Patience. The time invested upfront with each of you to formulate a solid and adaptable financial plan discussing liquidity, cash flows, and reserves provides solid footing for times like these with many changing facets.

We greatly appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.

As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we would be happy to discuss.

We wish you, your families, friends and colleagues all the best health and peace of mind as we ride out the challenges of 2020 together.

Please follow this link to read the complete Quarterly Market Review | 2Q 2020.

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