Stocks surged higher in the second quarter of 2020, a rally all the more remarkable given the almost total absence of reassuring economic news. Just as the speed of the decline in the stock market in the first quarter tested historical precedent, second quarter gains were equally worthy of the history books. Specifically, after hitting the bottom on March 23 the S&P 5001 rose by an astonishing 40% over the next 100 days.2 The last time a similarly huge gain was posted this quickly was 1933.3 (That rally did not work out well for long. 18 years later stock prices were lower.)
With countless businesses around the world closing their doors to employees and customers alike, investors turned their gaze elsewhere and were seemingly cheered by the anticipated future economic effect of massive governmental intervention. In the United States alone the federal government spent almost $300 billion on recovery rebate checks, an incremental $270 billion on unemployment benefits, $760 billion on small business relief (mostly subsidization of payroll and rent,) $425 billion on health-related spending, $150 billion on direct aid to state and local governments, and more than another $500 billion on, as it were, this and that. The total spend of roughly $2.4 trillion equates to almost 12% of GDP.4
Not to be outdone, the Federal Reserve was yet more aggressive. Since March 3 it has cut the federal funds rate (the rate banks pay to borrow from each other) by a total of 1.5% and down to a range very close to zero. The federal funds rate indirectly affects longer-term rates, and lower rates benefit those who seek mortgages, auto loans, home equity loans, and so on. The Fed has also pledged to keep rates low until maximum employment is achieved. Since the official unemployment rate in June was 11.1% that is likely a long time, indeed.
In addition to cutting rates, the Fed expanded its balance sheet to over $6 trillion via the purchase of Treasury securities, mortgage-backed securities, municipal bonds, investment grade and even (indirectly) junk bonds. By means of analogy, imagine losing your job and trying to raise cash by holding a garage sale. It’s not going well but then Bill Gates pulls up in his Ferrari, points cheerfully at every last thing in your driveway and says, “I’ll take all of it. Even the leaky garden hose. And I’m not especially curious about your prices.” That would be a good day for you, and it helps explain why even dodgy bonds did well in the second quarter.
This spending, borrowing and lending spree helped power the S&P 500 to a second quarter gain of 20.5%, which in turn dropped half-year losses down to 3.1%. The average S&P 500 stock fell almost 11% in the first half but the index is capitalization weighted, which means that the biggest companies drive the overall return. Value stocks, as represented by the Russell 1000 Value Index5, rose 14.3% in the quarter but still fell 16.3% in the first half of the year. Small company stocks also popped in the second quarter, rising almost 25.4%, bringing half-year losses in the Russell 2000 Index6 to 13.0%.
Government spending and central bank activism was common to one degree or another throughout the world’s dominant economies, and in part for this reason foreign stocks also recorded double digit gains. The MSCI EAFE Index7 of foreign stocks rose 14.9% for the quarter, dropping first half losses to 11.3%. In light of arguments about the origins of the COVID virus, it is remarkable that among the world’s best performing stock markets in the first half of 2020 was that of China, which actually rose 3.5%.8
In the bond market, lower yields pushed prices higher. The Aggregate Bond Index9 rose 2.9% in the quarter and was up 6.1% for the half-year. Municipal bond markets stabilized during the quarter and the National Muni Bond Index10 rose more than 2.7% after having fallen modestly in the first quarter. Many states are staring at big budget problems and, unlike the federal government, the states can neither run deficits nor print money. In this election year, the odds are excellent that swing state governments are going to be wined and dined by Washington politicians. There will be at least one more round of big transfers to states and local governments.
Commodities markets often tell an interesting story. Gold rose 13.0% in the quarter for a 17.1% year-to-date rise, making it among the world’s best investments thus far in 2020. At the other end of the spectrum, the price of physical oil and gas fell by double digits in the quarter. The energy sector of the S&P is down 35.3% for the half-year.
A Pony Somewhere
The set-up for an old joke is that parents take their insanely optimistic boy to see a psychiatrist. Seeking to persuade the child that he lives in an often harsh world, the doctor escorts him to a room filled with nothing but manure. But rather than show discouragement, the boy clambers to the top of the pile and starts to dig. “What are you doing?” the psychiatrist asks. “With all of this manure,” the boy happily replies, “there must be a pony in here somewhere.” In the current environment, some have wondered if buyers of stocks are perhaps guilty of looking for their own pony.
It is in fact often the case that every investment signal seems to point in the same direction, be it good or bad. In the seemingly ancient history that was 2019, for example, the strength of the U.S. economy and the stock market alongside it seemed all but unstoppable. We recall that when asked about their single greatest problem, businesses complained about a lack of workers. For their part, many workers complained that their commuter trains and freeways were too crowded. That was then, as they say.
The news that accompanied the big stock market gains of the second quarter, by contrast, was almost always of a kind that leads to lower prices – sometimes much lower. On the domestic scene, we confronted unimaginable levels of unemployment, yawning economic inequality and (for some) new and unanticipated fears of domestic unrest. In part for these reasons, Joe Biden surged to a big lead in the polls while promising to increase corporate taxes dramatically – a political candor last displayed by Walter Mondale prior to his 49-state loss to Ronald Reagan in 1984. We have no dog in any fight over tax legislation, but all else being equal, investors should demand lower prices for corporations that may soon pay more in taxes. Overseas developments might have been expected to hurt stock prices, too. We recall that when stocks plunged in the 4th quarter of 2018, the primary explanation proffered at that time was that investors were nervous about the risk of a U.S.-China trade war, including costly tariffs. But news on the trade front also got significantly worse in the most recent quarter. Indeed, Donald Trump and Joe Biden compete to show who will be tougher on China.
In the second quarter, therefore, investors looked beyond many traditional sources of concern in bidding up stock prices. At times like these, it is helpful to remember how quickly investor psychology can change from optimism to pessimism. This moment is filled with uncertainty for which broad diversification is the sensible response.
1. References to the S&P 500 refer to the S&P 500 Total Return Index which is a market capitalization-weighted index that generally contains the 500 largest publicly traded stocks in the U.S., subject to certain restrictions. The index includes the reinvestment of dividends. An index is unmanaged and not available for direct investment.
2. Source: Bloomberg.
3. ‘S&P 500 Index – 90 Year Historical Chart’; https://www.macrotrends.net/2324/sp-500-historical-chart-data
4. JPMorgan Guide to Markets, June 30, 2020, page 25.
5. Russell 1000 Value Index: A market capitalization-weighted index composed of constituents in the Russell 1000 Index with low price to book ratios and lower forecasted growth rates. An index is unmanaged and not available for direct investment.
6. Russell 2000 Index: A market capitalization-weighted index of U.S. small cap stocks that consists of the 2,000 smallest publicly traded stocks in the Russell 3000 Index. An index is unmanaged and not available for direct investment.
7. MSCI EAFE Index: A market capitalization-weighted index that captures large and midcap companies in developed countries around the world, excluding the U.S. and Canada. An index is unmanaged and not available for direct investment.
8. Source: MSCI. Return shown for China is the return of the MSCI China Index for the first two quarters of 2020. The MSCI China Index is an index of large and mid-cap companies domiciled in China and covers about 85% of the China equity universe. An index is unmanaged and not available for direct investment.
9. Bloomberg Barclays US Aggregate Bond Index: A broad-based bond index that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government agency bonds, corporate bonds and securitized fixed income securities. An index is unmanaged and not available for direct investment.
10. Bloomberg Barclays Municipal Bond Index: An Index that covers the USD-denominated long-term tax exempt bond market. The index includes state and local general obligation bonds, revenue bonds, insured and prerefunded bonds. An index is unmanaged and not available for direct investment.
Written by Jeff D.Lancaster, CFP®, Principal; [email protected]
|Index11||Market||03/31/20 – 06/30/19||Year-to-Date – 06/30/20|
|Standard & Poor’s 500||Large Co. U.S. Stocks||20.5%||-3.1%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||14.3%||-16.3%|
|Russell 2000||Small Co. U.S. Stocks||25.4%||-13%|
|MSCI All-Country World ex U.S.||Foreign Stocks||16.1%||-11%|
|Barclays 1-5 Year Gov’t/Credit||U.S. Shorter-Term Taxable Bonds||1.8%||4.0%|
|Barclays Aggregate Bond||U.S. Taxable Bonds (Broad-based)||2.9%||6.1%|
|Barclays 1-5 Year Muni Bond||U.S. Shorter-Term Tax Exempt Bonds||2.2%||1.8%|
|JPMorgan Global Ex-U.S. Bonds||Hedged Foreign Bonds||1.1%||2.6%|
Key economic indicators compiled by Jeffrey Blanchard, CFA, Director of Research; [email protected]
11. Index Glossary:
Standard & Poor’s 500: A market capitalization-weighted index that generally contains the 500 largest publicly traded stocks in the U.S., subject to certain restrictions. The index includes the reinvestment of dividends. An index is unmanaged and not available for direct investment.
Russell 1000 Value Index: A market capitalization-weighted index composed of constituents in the Russell 1000 Index with low price to book ratios and lower forecasted growth rates. An index is unmanaged and not available for direct investment.
Russell 2000 Index: A market capitalization-weighted index of U.S. small cap stocks that consists of the 2,000 smallest publicly traded stocks in the Russell 3000 Index. An index is unmanaged and not available for direct investment.
MSCI All-Country World ex U.S.: A market capitalization-weighted index that captures large and midcap companies in developed and emerging market countries excluding the U.S. An index is unmanaged and not available for direct investment.
Barclays 1-5 Year Gov’t/Credit: A broad-based bond index that measures the non-securitized component of the US Aggregate Bond Index and targets bonds with maturities between 1 and 5 years. An index is unmanaged and not available for direct investment.
Barclays Aggregate Bond: A broad-based bond index that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government agency bonds, corporate bonds and securitized fixed income securities. An index is unmanaged and not available for direct investment.
Barclays 1-5 Year Muni Bond: An Index that covers the USD-denominated tax exempt bond market with maturities of 1-5 years. The index includes state and local general obligation bonds, revenue bonds, insured and prerefunded bonds. An index is unmanaged and not available for direct investment.
JPMorgan Global Ex-U.S. Bonds: An index constructed of government bonds issued from developed countries outside the U.S. with the currency exposure hedged backed to the U.S. dollar. An index is unmanaged and not available for direct investment.
12. Bloomberg Commodity Index: This index reflects the return of a broad basket of commodity futures contracts with the collateral invested in 3 month Treasury Bills. An index is unmanaged and not available for direct investment.
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