Q2 2020 Market Review
Halfway through 2020, investors are finding themselves perplexed by the significant rise of the markets after the first quarter when the markets fell 30% in just thirty days. As the U.S. economy began to reopen, hopes began to emerge that the economic downturn would be brief with the significant stimulus of central banks and governments around the world.
Major stock indices recovered much of their losses in the second quarter, with the S&P 500 and Dow Jones Industrial Average each rising nearly 20% and the NASDAQ returning just over 30%. The major indexes have indeed recovered much of their first-quarter losses, but when you look closer under the hood, most stocks in the S&P 500 remain down for the year, with performance driven mainly by just a handful of growth-oriented companies. The S&P 500 is a market-cap weighted index, with stocks such as Microsoft, Apple, Amazon, Alphabet, and Facebook, now accounting for over 20% of the index. The strong year-to-date performance of these stocks and their impact on the index can mislead investors to believe the market is doing better than it is because many of the 490+ balance of the stocks in the index are telling a much different story. The last time we saw so few companies drive the entire performance of the index was during the dot-com bubble of twenty years ago. That crisis did not end well for those that speculated on the "next great thing on the internet." Patient, well-diversified investors were rewarded without a permanent loss of capital.
Fiscal and Monetary Response Fuels the Quarter
Unprecedented fiscal and monetary stimulus have fueled the rise in risk assets, including equities and fixed income, with the Federal Reserve continuing to inject an enormous amount of liquidity into the financial system to help combat the economic impact of the virus. There is a common phrase in investing, "Don't fight the Fed,” meaning investors should invest in risk assets when the monetary policy is accommodative. The Fed has stated that they will work hard to support the economy, and we expect that accommodative policies are here for the long-term. Significant stimulus by Congress has also played a significant role, providing fiscal packages such as the CARES Act and Paycheck Protection Program to help cushion the economic impact of the virus. We can only hope that Congress and the President can continue providing stimulus with a new Covid-19 relief package being proposed this week, but even my 13-year-old understands the challenges we face there.
The Shape of the Economic Recovery
While I don’t care for the use of letters to describe the economic cycle over time, investors have been betting on a “V” shaped, quick economic recovery out of the current recession. Economic data is now suggesting some wrinkles in the right side of that anticipated "V” as Covid-19 continues to slow down the recovery. We have been advising clients since March that there would be a significant bounce in asset prices off the bottom based on the long history of bear markets, but that we are more likely to experience some type of a “W” recovery, one where the economy recovers rapidly and then falls into a second period of decline before recovering. While the economy was in good shape before this crisis, we cannot ignore the harsh reality that many businesses will not survive and that unemployment will likely remain high for some time. With that said, we have seen a great deal of improvement in economic data, and positive movements of any kind can often stimulate markets. Still, output and unemployment remain far below pre-pandemic levels, and it will take time to fully understand the extent of the pandemic's economic impact. Every crisis creates new opportunities to take advantage of in portfolios; the current pandemic is no different. Expenditures in health care should continue to be robust, and the pandemic has forced businesses to transition to a new way of working from low-tech to high-tech. There will also likely be a greater diversification of supply chains so that we are not so heavily reliant on one nation, which will hopefully translate to an increase in domestic manufacturing.
During many client conversations, clients are often confident in the behavior of markets in either direction based on the information they have digested in the news and social media. It is important to understand that market performance is based on numerous economic factors, and that changes are not simply based on the headline of the day and are often already factored into asset prices. It it is frequently the unknown that will likely have a greater impact on market direction. As we have seen over the past quarter, the headlines are mostly negative, but improving economic data (there is a great deal), while still weak, is serving as a significant impetus in moving markets upward for now. It is important to remind ourselves that it is difficult to forecast in the short-term, and trying to time the markets has always been a poor investment strategy. We are also headed into a major election, which contributes to the uncertainty and may lead to more stock market fluctuations, as we move closer to November. While we always caution clients not to jump to conclusions before an election, the race will undoubtedly have an impact on investor sentiment and market prices. Both candidates present risks and opportunities, and history suggests that the markets will do fine whether or not we have a Democrat or Republican as President. The next term will likely begin with stubbornly high unemployment, and the President and Congress will likely push through a large infrastructure package with the hope of getting people back to work.
Each crisis throughout my career has provided an opportunity to speak with clients on a greater frequency, and my team works very hard to be here for you and provide perspectives on what is going on in the markets and your accounts. I continue to be optimistic in long-term plans, with the complete understanding that there will be bumps in the road. We have remained invested, albeit defensively in most cases, and continue to hold cash and other asset classes in portfolios. Please keep reaching out to us with any questions and any changes in your personal lives that may impact your financial plan. Most importantly, stay well, and enjoy the rest of your summer! Thank you as always for your business and trust.