2nd Quarter 2020 Market Commentary: COVID-19 (Coronavirus) – Markets Seesaw Between Prospects for Medical Treatments versus 2nd Wave Outbreaks
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June 2020 Highlights:
- Global markets continued their advance on the hopes of progress being made on COVID-19 / coronavirus medical treatments as well as signs that the worst of the global economic contraction may be behind us. MSCI All-Country World Index (ACWI) returned 3.2% for the month led by Emerging Markets (up 7.4%) followed by international ex-U.S. developed (MSCI EAFE up 3.4%) and the U.S. (S&P 500 up 2.0%).
- The early part of June saw a sharp recovery of beaten down cyclicals, small caps, and inexpensive (value) stocks only to see much of that relative outperformance dissipate as news emerged over rising COVID-19 net positive cases across much of the U.S., especially southern and southwestern states that had lifted shelter-in-place restrictions.
- Much of this month’s surge in new positive coronavirus cases can be tied to younger people, who appeared to have thrown caution to the wind and reengage in close quarter social activities such as frequenting bars and nightclubs, prompting Texas and Florida to shut down bars, delay reopening of water park venues, and reduce restaurant capacity. Although the mortality rate is expected to be lower across younger age bands, the increase in infections is starting to put a strain on the healthcare system due to higher hospitalizations. Meanwhile, Oxford University warned United Kingdom lawmakers to “prepare for the worst” as scientists scaled back expectations that a coronavirus vaccine breakthrough would arrive before the cold winter months.
- MSCI Asia-ex-Japan led major developed market regions rising 8.2% followed by MSCI Europe (+4.1%) and the U.S. (S&P 500 +2.0%). MSCI Japan was a notable laggard returning flat for the month after outperforming in May. International market performance was helped by a weaker U.S. dollar (down from its mid-March funding shortage peak) as global central banks unwound currency swap arrangements that provided emergency U.S. dollar funding during the height of the mid-March panic.
- European stocks rallied over the prospects of a Eurozone pandemic relief fund for southern countries (primarily Italy) hardest hit by the coronavirus. Beaten down European bank stocks rallied following the European Central Bank’s sweetening of terms for member banks to participate in the EUR1.3 trillion Targeted Long-Term Refinance Operations (TLTRO III) program that effectively pays banks for their participation as a means to inject more liquidity into the Eurozone economy.
- Despite few signs of a letup in COVID-19 cases across Latin America and India as well as China’s surprise shutdown of Beijing due to a second outbreak, emerging market equities and currencies performed well primarily due to perceived progress in U.S./China trade negotiations (despite mixed signals from both China and the U.S. over security issues tied to Hong Kong and Taiwan) as well as additional central bank rate cuts announced by Russia, Brazil, and Indonesia. China also appears to be ramping up infrastructure spending as a means to jumpstart the economy.
- At one point early in the month, U.S. small caps had returned ~8% in excess of large caps and then surrendered much of that outperformance over the course of the month as investors’ hopes for a V-shaped recovery gave way to the prospects of another shutdown brought on by a 2nd coronavirus wave. The S&P 500 (large caps) returned 2.0% while the S&P 600 (small caps) returned 3.0%. Similarly, value stocks surrendered much of their early outperformance over growth stocks with the S&P Pure Value returning 2.1% versus 2.7% for S&P Pure Growth.
- Technology and consumer discretionary stocks (primarily e-tailers) led in June as investors continue to favor ‘shelter-in-place’ growth themes. Defensive sectors such as utilities and healthcare lagged as did the energy sector, dragged down by a month-end sell-off in oil prices.
- Among factors, Momentum outperformed all other factors with even 2020 factor stalwart High Quality underperforming the S&P. Minimum Volatility, High Dividend, and Value underperformed as investors increasingly focused on pure growth momentum themes.
- Among equity alternatives, U.S. REITs returned 2.3% for the month after having risen as high as 12% earlier in the month. S. commercial real estate experienced renewed selling pressure as investors now expect more lockdown measures to be imposed in response to the rise in coronavirus infections. Precious metals turned in a positive month (+2.5%) after having been down earlier in the month, while commodities outperformed equities, returning 5.1% on the strength of oil prices and industrial metals (copper). The 3-month generic oil price settled at $39.48/barrel, up from a low of $18/barrel in late April.
- Investment grade fixed income posted a positive month helped by a combination of lower interest rates and narrower credit spreads. Corporate bonds continue to benefit from the Federal Reserve’s emergency lending facilities that has resulted in the purchase of $7 billion in corporate bond exchange-traded funds since the program began in mid-May. The Fed also disclosed that it purchased $428 million individual corporate bonds through the Secondary Corporate Credit Facility with an end goal of purchasing up to $250 billion or ~3.5% of the Fed’s current balance sheet. The U.S. Bloomberg/Barclays Aggregate Index returned 0.6% for the month. U.S. High Yield continues to recover from the 1Q20 sell-off, returning 1.0% for the month, although high yield surrendered early month gains due to the rise in coronavirus infections.
- Following an early month sell-off in reaction to an unexpectedly strong U.S. employment report, U.S. Treasuries have now settled into a narrow range of 0.60-0.70%. The U.S. 10-Year Treasury ended the month at 0.65% after having spiked to 0.90% following the strong May employment report released earlier in the month. The Federal Reserve continues to strongly hint at implementing yield curve control where the Fed would target Treasury rates, possibly out to seven years, as a means of maintaining monetary stimulus (as well as aiding U.S. Treasury borrowing needs). This has helped flatten the U.S. yield curve (difference between short versus long rates) which still remains positive. With 1.5% long-term inflation implied by breakeven rates between U.S. TIPs versus nominal Treasuries, the bond market is bracing for slow non-inflationary growth, but not deflation.
- With the rally in U.S. equities, the S&P 500 now trades near a 10-year high at 21.6 times next 12 month’s expected earnings. The multiple expansion to new 10-year highs is a result of both global equity rallies and declining forward earnings expectations due to the global economic shutdown. According to Factset Earnings Insight (6/26/2020), Wall Street analysts are expecting a sharp recovery in earnings and revenue for S&P companies in 2021 following a sharp decline in 2020. Consensus analyst estimates for S&P earnings are expected to decline 21.6% (revenue down 3.9%) in CY2020 but recover 28.8% (8.5% revenue growth) in CY 2021.
- This quarter’s rally in global equities and corporate credit suggest that investors continue to back away from a worst case deflationary scenario and price in expectations of an eventual recovery, hoping the renewed rise in coronavirus infections won’t result in another economic lockdown (perhaps just restrictions on social gathering venues such as bars and restaurants). Going forward, we expect market volatility to continue as investors wrestle with daily coronavirus headlines and whether optimistic outlooks for a recovery are getting too ahead of themselves.
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By: Benjamin Lavine