May 2020 Market Commentary: COVID-19 (Coronavirus) and Digging Out of the Deep Hole
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May 2020 Highlights:
- Global stocks continued their 2nd quarter recovery from the steep 1st quarter sell-off that saw the S&P 500 enter deep bear market territory for the first time since the 2008 Financial Crisis. Global markets as represented by MSCI All-Country World Index or ACWI were up 4.3% in May.
- Despite some early month weakness driven by cautious comments from famed investors (Warren Buffett, Stanley Druckenmiller, David Tepper), global equities rallied over positive COVID-19 vaccine developments and signs of an early economic recovery.
- Developed markets outperformed emerging markets which continue to disproportionately suffer from the COVID-19 pandemic. MSCI Japan led all major regions up 5.9% followed by U.S. Stocks (S&P 500) up 4.8% and MSCI Europe up 4.6%. MSCI Emerging Markets (+0.8%) and MSCI Asia ex Japan (-0.3%) were notable laggards as the region suffered from the China’s initiative to impose a security crackdown on Hong Kong.
- Sharp stock rallies have mostly occurred around positive developments concerning potential COVID-19 treatments (Gilead’s Remdesivir) and vaccines (Moderna). Moderna’s potential success in formulating a COVID-19 vaccine could be a game changer for helping the world move past the pandemic and further ease the shutdown. Travel and leisure-related stocks have seen sharp rallies as they now trade with a high beta to positive COVID-19 developments.
- Europe and Japanese markets performed well over increased pandemic relief measures. Japan led the rally among Asian-Pacific stocks as Prime Minister Shinzo Abe announced that the state of emergency will be lifted in a handful of prefectures, signaling progress in the country’s lifting of economic quarantines.
- In Europe, EC President Ursula von der Leyen proposed an increase in the EU’s budget (known as the multi-annual financial framework) of 750 billion financed by jointly issued debt among member countries.
- U.S. small caps had briefly outperformed large caps up until the last week when the markets had pulled back due to the escalating tensions with China. S&P 500 returned 4.8% while the S&P 600 returned 4.3%. Growth stocks continued their outperformance over value stocks as S&P Pure Growth returned 8.3% versus 3.0% for Pure Value.
- Energy gave up some of its April outperformance and ended up as the one of the worst performing sectors despite the strong rally in commodities. Overall, growth sectors such as Technology and Communication Services led sectors as did traditional cyclicals such as Materials and Industrials while defensive sectors (Staples) and Financials/Real Estate lagged.
- Among factors, Momentum and High Quality outperformed Minimum Volatility, Value and High Dividend. Momentum and High Quality are increasingly overlapping with one another, reflecting investor preference for premium growth stocks.
- Fixed income posted another positive month, helped by the continued recovery in corporate credit and mortgage-backed/asset-backed sectors. The U.S. Bloomberg/Barclays Aggregate Index returned 0.5% for the month as the 10-Year US Treasury Yield has settled in a 0.60-0.70% range (0.65% at month end), off the March low of 0.50%. U.S. High Yield continues to recover from the 1Q20 sell-off, returning 4.4% for the month.
- The 2-10 Year Term Structure remains positively sloped as fixed income investors do not expect the Fed to raise rates from the zero level anytime soon while inflation expectations implied by breakeven rates between TIPs and nominal Treasuries have declined despite consumer perceptions of higher prices (primarily groceries due to shelter-in-place).
- The Federal Reserve’s emergency measures (quantitative easing, primary and secondary market backstops, commercial paper and municipal facilities, and dollar swap arrangements with an expanded group of foreign central banks) announced in late March helped put a bid underneath risky assets.
- Commodities continue their rally following the plunge in oil prices back in April. The 3-month generic oil price settled at $36/barrel, up from a low of $18/barrel in late April. Industrial metals also advanced as China appears to be increasing its commodity purchases. Real estate continues to lag over concerns on how the coronavirus pandemic will affect occupancy rates.
- With the rally in U.S. equities, the S&P 500 now trades at a 10-year high of 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.
- Fixed income and commodity markets have been fixated over issues of ‘insolvency,’ while equity markets are mostly focused on ‘liquidity’ figuring that the global fiscal and monetary response to COVID-19 would open up frozen capital markets and provide enough bridge financing for Main Street businesses to traverse the economic chasm. That and the fact that investors are betting on large cap ‘winners’ (technology growth, stay-at-home beneficiaries) and investment-grade borrowers’ abilities to take advantage of the new issue market now backstopped by the Federal Reserve.
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By: Benjamin Lavine