Only three months ago we were staring down a depression of seemingly epic proportions as a result of the COVID-19 virus. During a period of 33 days, stocks worldwide dropped like a stone, with other asset classes experiencing similar declines. In some ways, the month of March was reminiscent of the six months from September 2008 to February 2009, when markets seemed to be in a death spiral with no end in sight. Like today, the months during the Great Recession were challenging times for investors.
If I had predicted in early April that just three months later, stocks would have rebounded and recouped most of their losses, you would have laughed at me. Yet, here we are. During the second quarter, there was a complete turnaround in sentiment, reflecting rising optimism for a vaccine for the COVID-19 virus and a nascent economic recovery.
The second quarter of 2020 was the best quarter for U.S. stocks in more than 20 years; the S&P 500 gained 20.5%, small-cap stocks in the Russell 2000 Index snapped back 25.4%, and fixed income markets stabilized, with the Barclays U.S. Aggregate Bond Index rising 2.9%. International equities, as represented by the MSCI EAFE Index, also recovered as well, rallying by 15.1%. And emerging markets bounced back by 18.2% during this same period.
Data Ending 6/30/2020 (not annualized if less than 1 year)
|Equities Indices||Q2 2020||YTD||1 year||3 years||5 years||10 years|
|MSCI ACWI (All Country World)||19.4%||-6.0%||2.6%||6.7%||7.0%||9.7%|
|S&P 500 (U.S. Large Cap)||20.5%||-3.1%||7.5%||10.7%||10.7%||14.0%|
|Russell 2000 (U.S. Small Cap)||25.4%||-12.9%||-6.6%||2.0%||4.3%||10.5%|
|MSCI EAFE (International Developed)||15.1%||-11.1%||-4.7%||1.3%||2.5%||6.2%|
|MSCI EM Emerging Markets (International Emerging)||18.2%||-9.7%||-3.1%||2.3%||3.2%||3.6%|
|Fixed Income Indices|
|FTSE World Government Bond Hedged (Global Bonds)||1.1%||5.1%||6.8%||5.5%||4.6%||4.1%|
|Barclays U.S. Aggregate (U.S. Investment Grade Bonds)||2.9%||6.1%||8.7%||5.3%||4.3%||3.8%|
|Barclays Municipal Bond 5Y (4 – 6) (Municipal Bonds)||3.3%||2.2%||3.8%||3.1%||2.8%||2.9%|
|Barclays U.S. Corporate High Yield (U.S. High Yield)||10.2%||-3.8%||0.0%||3.3%||4.8%||6.7%|
|S&P Developed REIT (Global Real Estate)||11.4%||-20.3%||-14.5%||-0.1%||3.1%||8.4%|
|HFRI FOF: Conservative Index (Diversifiers)||3.9%||-3.6%||-2.1%||1.4%||1.1%||2.4%|
Source: Zephyr Analytics and Morningstar
To a large degree, the market bounce resulted from fiscal stimulus enacted by Congress and supportive monetary policy of the Federal Reserve. The U.S. Government has pulled out all the stops to blunt the economic impact of the pandemic.
The CARES Act, signed into law on March 27, authorized over $2 trillion (yes, trillion with a “T”) of coronavirus relief spending to aid individuals, businesses and state and local governments. To put that in perspective, the U.S. federal budget deficit was originally projected to be a little over $1 trillion in 2020, so the new spending will triple the budget deficit. Depending on how things unfold for the rest of the summer, legislators have discussed potential additional stimulus measures. Putting money directly in the hands of businesses and consumers, which the CARES Act has done through business lending programs and checks to individuals, is a powerful tool to bolster the economy.
In addition, the Federal Reserve has taken numerous steps in response to the economic slowdown: lowering the federal funds rate to zero and providing liquidity/stability in the corporate bond market by buying bonds of U.S. corporations. I hate to use the word, but these actions are truly unprecedented. The Federal Reserve has never purchased corporate bonds before.
Long-term rates have responded to the actions of the Fed, with the benchmark 10-year treasury yield falling from 1.14% in the end of February to 0.65% in the end of June. Low interest rates have a stimulus effect because they allow companies to fund business growth and modernization while locking in low borrowing costs for years This could have a lasting and positive impact on corporate earnings and, subsequently, on stock valuations. Moreover, the Federal Reserve Chairman Jerome Powell has said that the Fed will do “whatever it takes” to support the U.S. economy during the pandemic. There’s an old saying in the investment world: “You can’t fight the Fed.”
There has been a lot written about what the shape of the output graphs will look like when this is all over. Will it be the much hoped for V-shape (rapid decline followed by rapid recovery), the dreaded W (double dip recession), or the square root symbol (rapid decline followed by rapid partial recovery leading to a plateau)? All this is pure speculation and will depend, in large part, on how the pandemic itself plays out. But consider this interesting fact: according to FDIC data, over $2 trillion has flowed into U.S bank accounts since February, representing a 15% increase in bank deposits nationally. Much of that has been the result of stimulus payments. U.S. businesses have deposited some of the PPP loan proceeds. For consumers, the dramatic drop in spending this spring translated to record savings. This money won’t sit in banks forever at near zero interest rates: sooner or later it will be deployed on business ventures, vacations, dinners out, and the like.
Too Much Too Soon?
Despite the aggressive fiscal and monetary stimulus, the fundamental realty is still quite sobering. Although some economic trends are improving, we are still facing an economy where small business owners are struggling, and reopening efforts are stalling and even reversing in some parts of the country. It is likely we will continue to face double-digit unemployment and negative gross domestic product well into the second half of 2020. We still do not have an effective, safe, or widely available vaccine for COVID-19. Without a vaccine it will be hard for the economy to function at full capacity and for things to return to normal.
We know that stock prices are generally a leading economic indicator. In the past, stocks have often anticipated changes in the economy, in both directions. So, it’s not a huge surprise that stocks have risen on simply “less negative” news, especially following such an historically rapid fall during the first quarter.
But the big questions du jour are these: Is this rebound too good to be true? Have financial markets run too hard too fast? Have stock prices become disconnected from economic reality, teeing us up for a rude awakening in the form of another market rout in the not-to-distant future?
Maybe…but not necessarily. The truth is, no one knows, and you should ignore anyone who claims to have the answer. For the sake of your peace of mind, consider turning off the television and the Twitter feed. If the last six months have demonstrated anything, they’ve demonstrated that anything can happen. I can’t think of a single economist or prognosticator who predicted the way events unfolded or the market response to those events during the last 6 months. Let’s all stop paying attention to short-term forecasts!
But here’s one thing you can hang your hat on: the management teams of the several thousand companies that make up the U.S. and global stock markets go to work every day with the goal of figuring out how to be more profitable and make more money for their shareholders. Betting against human ingenuity and adaptability has historically been a losing bet. Many businesses, including Modera, have been able to utilize technology to continue our work and stay connected with one another and our clients. In fact, technology enablement is a big part of the economic story. Many parts of the global economy could not have functioned at all if COVID-19 had hit 15 years ago, when remote team collaboration and mobile communications technology were mostly unavailable.
I can tell you also that I remember hearing similar concerns about “too much, too soon” during prior recessionary periods when stocks rallied in advance of the economic cycle bottoming. This was especially true during the summer of 2009 and 2010. Anyone who based their investment decisions on negative predictions and downbeat news stories through those years suffered serious long-term financial damage, missing a significant, permanent market advance. It is normal for the stock market to turn upward while the economic data is still terrible, and people are feeling discouraged. I expect this time will be no different.
The year 2020 cannot end soon enough for a lot of people, myself included! The wild swings in financial markets to-date have our heads spinning (even those of professionals, who invest money every day for a living). It will take years for us to fully measure the human cost of the pandemic, in terms of lost lives, mental health, and standards of living. If the pandemic isn’t bad enough, we are experiencing civil unrest rivaling that of the 1960’s and a political environment that is more divisive than I can remember in my lifetime.
The Federal Reserve and Congress have poured a historic amount of debt-driven stimulus into the economy during 2020 to keep people and businesses afloat. This was necessary to stem the bleeding and provide a bridge across rough economic waters. But this kind of stimulus does not come without its own potential longer-term financial and economic risks. There will be a lot of ink expended over the coming years, by myself and others, analyzing the long-run implications of tripling our deficit to mitigate the economic downturn. The consequences are far from clear and I look forward to exploring that in the future.
The stunning rebound we have seen in financial markets during the second quarter does not guarantee that we are out of the woods and back to normal. There could easily be more volatility ahead in the second half of 2020 as we try to wade through more uncertainties and economic bad news. However, I believe this economic recovery will be like many others before it, in that the markets will turn decisively upward before we all start to feel better about things.
Our job at Modera Wealth Management LLC is to work with you to establish a financial plan and help you manage your wealth to that plan, regardless of the ups and downs of the market. Some years our job is harder than others. I have great optimism that as humans, with our endless capacity to innovate and collaborate, we will rise to the challenges before us, conquering the pandemic and mending the divisions in our society. The Modera team looks forward to talking with you about your plans and investment strategy through this difficult year and beyond. Stay healthy and safe!
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S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. FTSE Russell is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2020, all rights reserved. Bloomberg Barclays data provided by Bloomberg.