One For The Books
The first half of 2020 has produced enough major headlines to fill up the first half of most decades. Will the second half of the year be filled with even more? This question, along with what the next six months mean for the stock market, has many of our clients wondering where we stand in the current environment and what lies ahead.
At CPWM, there is only one known fact about where we go from here – that fact being that the future is unknown, but we believe that long-term equity market returns should prevail. Despite record setting unemployment and one of the worst contractions in GDP since the Great Depression and Global Financial Crisis (GFC), there are segments of the stock market that have recently hit their record highs (NASDAQ Composite at 10,221 – up nearly 55% since the March low). How can that be? We are still in the thick of the COVID-19 Pandemic. The economy is in recession. A presidential election is set to happen in November. How can the stock market be hitting all time highs with so much uncertainty ahead? Shouldn’t the market be correcting even more or, at the very least, it must go down from where we sit today? Maybe. But we aren’t willing to bet on it.
As we have communicated to our clients before, the market is an efficient machine that is constantly recalibrating by the second. Much like a barometer that helps us inform decisions about future weather, the stock market is our tool for assessing the possible future of the corporate success, profits, and perhaps to a degree – the economy. The severe collapse which kicked off the bear market in March is an example of this. The market moved swiftly to adjust for what many are predicting will be the worst recession since the Great Depression. This recession, however, wasn’t to be realized until Q2’20 GDP readings which are scheduled for release July 30, 2020 and are expected to be down almost 40%1. Let’s take a moment and let that sink in… The market dropped 34% peak-to-trough almost four months before economists were expecting to have the Q2’20 GDP data. On this thread, we must ask how one can be surprised that the market has recovered so much with Q3’20 GDP estimates (scheduled October 29, 2020) coming in at over +30% and +7% for Q4’20? We believe that this can be an indicator that the markets tend to look towards the future rather than dealing in the past. It adjusts to bad news and data forecasts instantaneously and often multiple months in advance of what might happen. Also, the market hates uncertainty more than bad news. Let’s take the example of the job report when we learned that 20 million jobs were lost by US workers in April, the worst month for job losses on record, but S&P 500 futures gained and closed the day up 1.7%. That’s because the market was expecting job losses of 22 million, so the bad news for the economy was the good news for the investors.
Another reason for the stock market rally could be low returns from bonds coupled with the monetary and fiscal policy measures. Bond yields going into the pandemic were already low, at levels we have never had going into a bear market. Fed had to lower rates even more in order to boost the economy, setting the target interest rate near 0%, which makes it hard for certain investors to justify moving out of Equities and into the Bond Market. At the same time, the Federal Reserve has injected a monumental amount of liquidity in the market, by buying bonds and supporting the money-markets as fiscal measures have provided stimulus checks and unemployment benefits. We believe that liquidity increases investors’ confidence and thus offers support for both the stock and bond markets.
It goes without saying – volatility is likely to continue. But predicting when volatility will change directions is difficult, if not impossible, with any accuracy or consistency. We aim to build our client’s portfolios in a way that sustains market swings and produces the best risk-adjusted returns that we can for each client’s unique situation.
1Source: The conference Board Economic Forecast for the US Economy – June 2020
Past performance is not be indicative of future results. All investment strategies involve varying degrees of risks and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable, or that such will equal any corresponding historical performance level. Nothing contained herein shall be deemed to be personalized investment advice.