Monthly Economic Update May 2020: Markets Rallied With Faster Than Expected Reopening & Optimism Over Potential COVID-19 Vaccine
The capital markets continued to rally through May, fueled by a faster than expected reopening of the economy, optimism over a potential COVID–19 vaccine and the perception governments will do whatever it takes to fortify businesses and markets. All major asset classes gained ground for the month, supported by government stimulus and rising demand for riskier, higher yielding assets. The U.S. government has been more aggressive in terms of fiscal and monetary policies than most other countries, with the notable exception of Japan. Coronavirus-related measures now account for 13% of U.S. GDP and may go higher. The U.S. stock market has recently outperformed many developed and emerging markets, but high valuations, civil unrest and contentious elections with major policy implications, could create a challenging and volatile environment in the months ahead.
In the equity markets, large cap technology stocks outperformed for the month, but market leadership rotated mid-month in favor of smaller companies and cyclical sectors such as financials and materials that were hardest hit during the coronavirus crash. Dividend stocks lagged as dividend cuts and fewer share buybacks reduced their yield advantage and expectations of higher tax rates made current income flows less appealing. The energy sector remained weak despite a rebound in energy prices. Real estate, both public and private, was hampered by fears that rent collection will deteriorate further and demand in the office, retail and hospitality sectors will not bounce back even as activity returns to normalcy. S&P 500 earnings fell 14% over the first quarter, with smaller companies experiencing even larger earnings shortfalls. Negative earnings revisions reached almost 50%. More pain is expected in the second quarter, but earnings forecasts are building in sharp rebounds for many companies by 2021. Although there may appear to be a disconnect between the real world and the stock market, investors are focused on the long-term outcome for company results.
Fixed income markets continued to rebuild after the massive sell-off and liquidity crunch experienced at the height of the coronavirus crisis. Long-term interest rates rose, and the yield curve steepened as the prognosis for the economy improved. Although Treasury yields remained near historical lows, with the 10-year skirting 1%, the risk of negative rates in the U.S. seems to have abated for now. Treasuries posted negative returns for the month, but other bond sectors had healthy gains. Improving sentiment, Fed asset purchases and upgraded fundamentals for some issuers shored up prices, sending credit spreads lower.
Asset flows stabilized following the $1 trillion shift into safe-haven money markets at the start of the coronavirus pandemic. Supply and demand were in balance as investors piled back into corporate and municipal bonds and lower rates caused new issuance to surge. Emerging market debt, buoyed by more stable currencies, also had a strong month.
Economic indicators pointed to a sharp slowdown in all segments of the economy but generally came in better than expected. Many key measures including business activity, retail sales and employment seem to have stabilized after rapidly deteriorating at the start of the health crisis. The housing market has been notably robust with building activity and home sales holding up well. Economic growth outside the U.S. has shown a similar sharp decline, but some countries that were earlier in the coronavirus cycle, including China, show signs of resurgence. The sinuous path of the coronavirus and the retrenchment in global trade may set in motion economic decoupling between countries that will strengthen the case for global diversification.
Recent events in the markets have once again proven that economic forecasting and market timing are nearly impossible tasks. Many market strategists believe the worst is behind us, but the global economy faces many risks. Although virus containment efforts appear effective, the number of cases is still rising globally, particularly in emerging countries. There is no concrete timeline for a vaccine or a reliable treatment. Tensions between the U.S. and China have reemerged and political uncertainty surrounding civil rights and the upcoming elections will influence investor sentiment. During this time of extreme uncertainty, we recommend that investors remain well diversified and not take large sector and style bets relative to benchmarks.
Disclaimer: This commentary was written by Craig Amico, CFA®, CIPM®, Senior Investment Analyst, Noreen Brown, CFA®, Director of Portfolio Management and Steven Melnick, CFA®, Senior Investment Analyst at Summit Financial, LLC., an SEC Registered Investment Adviser (“Summit”), headquartered at 4 Campus Drive, Parsippany, NJ 07054, Tel. 973-285-3600. It is provided for your information and guidance and is not intended as speciﬁc advice and does not constitute an offer to sell securities. Summit is an investment adviser and offers asset management and ﬁnancial planning services. Indices are unmanaged and cannot be invested into directly. The Wilshire 5000 Total Market Index measures the performance of all U.S.-headquartered equity securities with readily available price data; the Standard & Poor’s 500 Index (S&P 500) is an unmanaged group of securities considered to be representative of the stock market; the MSCI EAFE Index (Europe, Australasia, Far East) is a free ﬂoat-adjusted market capitalization index designed to measure the equity market performance of developed markets, excluding the U.S. and Canada; the MSCI Emerging Markets Index is a free ﬂoat-adjusted market capitalization index designed to measure the equity market performance of emerging markets; the Bloomberg Commodity Index measures the performance of an unleveraged, long-only investment in commodity futures that is broadly diversiﬁed and primarily liquidity weighted; the HFRI Fund of Funds Composite Index is an equally-weighted benchmark composed of over 400 domestic and offshore constituent funds having at least $50 million under management or having been actively trading for at least 12 months; the Bloomberg Barclays U.S. Aggregate Bond Index is a market capitalization-weighted index comprising Treasury securities, Government agency bonds, mortgage backed bonds, corporate bonds, and some foreign bonds traded in the U.S.; the Bloomberg Barclays Global Aggregate Ex U.S. Index measures the performance of global investment grade ﬁxed-rate debt markets that excludes USD-denominated securities. The Bloomberg Barclays Municipal Bond Index covers the U.S. dollar-denominated long-term tax-exempt bond market. Data in this newsletter is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Consult your ﬁnancial professional before making any investment decision. Past performance is no guarantee of future results. Diversiﬁcation/asset allocation does not ensure a proﬁt or guarantee against a loss.