The first six months of 2020 have arguably been one of the most turbulent periods in history. Market sentiment had remained exuberant in early 2020, following one of the best performing years for U.S. stock and bond markets in recent history. However, the impact of COVID-19 quickly sent shock waves across the world. Fear seemed to take over as many individuals grappled with protecting their families and their jobs or businesses. This panic spread through the markets, resulting in major market declines, until the Federal Reserve stepped in with its announcement in late March to offer unprecedented stimulus support.
The stock market has since erased most of its first quarter losses and while this is a positive outcome, many investors are struggling to understand what lies ahead. In this communication we will summarize both the Bear and Bull market cases that currently exist in the marketplace. Most importantly, the first half of this year has reaffirmed to us that maintaining a disciplined approach to a sound investment strategy is far superior than attempting to time the market.
2020 FIRST HALF HIGHLIGHTS
Index returns 1:
* Source: Total Return YTD as of 6/30/20, Bloomberg; see Chart A in Appendix
S&P 500 correction: Between February 19th and March 23rd, the S&P 500 index declined ~34%. Losses accelerated in March after a pandemic was declared and the U.S. went into a national state of emergency. A market bottom was reached on March 23rd when the Federal Reserve announced that it was prepared to release “unlimited” stimulus into the economy. (Chart B in Appendix)
S&P 500 recovery: Within 3 trading days, following the Fed announcement, the index rallied nearly 17.5%. Momentum continued as positive news regarding the virus started to outweigh the negative and within 18 trading days the index rallied nearly 28.5% off the lows. Gains accelerated into early June on the heels of vaccine optimism and the staggered reopening of the economy. The result was a 44% price appreciation in the index in only 53 trading days. (Chart C in Appendix)
Not to be overlooked thus far in 2020: A declared recession (and end to the longest Bull market and economic expansion in history), increased global tensions with China and Iran, a crash in oil prices, a Presidential impeachment trial and massive national protests to name a few.
THE BEAR CASE FOR STOCKS
The resurgence of COVID-19 cases in many states has led to a slowdown in reopening plans. This could potentially be a drag on the economic recovery, resulting in sustained levels of unemployment and slowing consumer spending.
What will happen when current government benefit programs run out. Will the benefits be extended, such as enhanced unemployment benefits and student loan and mortgage forbearance?
The National Bureau of Economic Research (NBER) determined that the U.S. entered a recession in February2. Could the current recession turn out to be more damaging to the economy than past recessions?
High unemployment. The U.S. unemployment rate in May was 13.3%, slightly down from 14.7% in April, which was the largest in records back to 1939.3 While this is already known and priced in to the market, it is uncertain how quickly individuals will get their jobs back and whether or not their jobs will still exist.
Federal debt is expected to rise to unprecedented levels based on the economic impact of the shutdown and the stimulus passed in response to COVID-19. The long term impact of negative real interest rates is relatively unknown as is the potential for inflation to resurface.
Remaining options for the Fed. The Fed has already reduced its Fed Funds target rate to near zero and has committed trillions of dollars to supporting financial markets, businesses and state and local governments. The concern is that the Fed cannot directly drive economic activity, despite the accommodative measures.
November election. In a normal year, an election such as we are facing in a few months, is reason enough to expect market volatility. Increasing probability of a sweeping victory by the Democratic Party, is perceived as a negative for the market.
Trade war with China. While a preliminary deal has been signed and negotiations are ongoing, this remains an extremely fluid and volatile situation.
Bankruptcies. The economic shutdown and uncertainty with the future has pushed many struggling companies into bankruptcy. This trend is expected to continue.
Stock valuations. Investors are concerned that stock valuations are back near all-time high levels, effectively pricing in a smooth and linear economic recovery by 2022.
THE BULL CASE FOR STOCKS
Fiscal and monetary stimulus will lead to a full economic recovery by the end of 2022. Pent up demand from the lockdowns will support this steady and linear recovery.
States are reopening. Despite the recent slowdown to reopening plans, the belief is that lockdowns are behind us and opening the economy is a necessary step to restart the economic cycle.
There is optimism regarding treatments for COVID-19 and a vaccine to be mass produced by early 2021.
Improving unemployment. While the current unemployment rate in May was 13%, expectations were as high as 20%. This was better than expected and an improvement from April’s numbers. A declining trend in unemployment will most likely be viewed favorably.
Support from the Fed. The Federal Reserve has been very aggressive and is expected to remain accommodative for an indefinite period of time. Rates are expected to remain near zero for the immediate future and the Fed continues to reiterate that it has an unlimited amount of stimulus to provide the financial markets.
Yield curve controls. Through its targeted purchase of Treasury Bonds, the Fed is able to control the yield curve, which is supportive for an economic recovery.
Improving economic data: New home sales in U.S. jumped 16.6% month-over-month in May (better than the 2.5% forecast) and retail sales in the U.S. jumped 17.7% from the previous month in May (better than the 8% forecast).4 While these are only a couple of data points, positive results such as these will continue to feed the Bull case.
Overall belief that the pandemic created an unnatural recession, essentially a conscious decision to shut down the economy, and thus comparisons should not be made to the hardest recessions and depressions of the past. Drawing a conclusion that the recovery should be faster than normal.
Chart A: 2019 Total Return of Major Asset Class Indexes
Source: Bloomberg; 2019 Total Return, International, Emerging market, S&P 500, Barclays Agg indexes
Chart B: S&P 500 Correction
Source: Bloomberg; S&P 500 index
Chart C: S&P 500 Recovery
Source: Bloomberg; S&P 500 index
1 - Source: Bloomberg: S&P 500 Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index
2 - Source: Trading Economics US GDP Historical Growth. https://tradingeconomics.com/united-states/gdp-growth
3 - Source: Trading Economics US Unemployment Rate: https://tradingeconomics.com/united-states/unemployment-rate
4 - Source: Trading Economics US Retail Sales and New Home Sales: https://tradingeconomics.com/united-states/retail-sales
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