Q2 2020 Market Commentary – July 8, 2020
Early on in this health crisis there was an influential paper called “The Hammer and the Dance” by Tomas Pueyo in which he called the initial period of lockdown to flatten the curve “the hammer” and the subsequent period of living with the disease and adjusting to regional outbreaks with ongoing measures as needed “the dance”. We now seem to be entering the period of “the dance”, with some states moving ahead with re-opening plans and other states delaying or even reversing re-opening plans. Until a vaccine is developed, “the dance” is likely the phase we’ll be in for some time.
In this environment of uncertainty, the speed and strength of the US stock market rebound shocked many observers in the second quarter. With COVID-19 still far from over and unemployment still high at 11.1% as of the June reading, the market has bounced back much more quickly than economic indicators have. On the one hand, this makes sense since the market is forward looking and is seeking to forecast earnings for many years into the future. On the other hand, both the duration and the severity of COVID-19’s impact on the economy are still far from certain, so volatility is to be expected as these forecasts change, and caution is warranted. While we are always cautious about forecasts, we feel the metaphor of “the dance” is likely to apply to markets as well.
Stock markets steadily bounced back off of their late-March lows until early June, bolstered initially by encouraging news about vaccines and then by declining COVID-19 cases as the quarter continued. Markets have hesitated since then, as U.S. case counts have risen in the South and West of the country and the U.S. has been unable to contain new surges as well as most other developed countries.
In the second quarter US stocks led the charge. The Russell 1000 index of US large company stocks had a total return (price and dividends) of 21.8% for the quarter. Small cap stocks had been harder hit in the first quarter, but also came back more strongly in the second quarter, earning 25.4% in total return. International stocks also rose, but less forcefully, as developed country stocks rose 14.9% and emerging country stocks gained 18.1%.
Bond returns have helped offset stock market losses this year, and have provided a steady return. In the first quarter, the Barclays Aggregate Bond Index returned 3.1%, and in the second quarter added another 2.9%.
The Federal Reserve has taken unprecedented steps to keep the economy and track as well as keeping markets calm. It reduced its benchmark interest rate to near zero in March, and created lending facilities for households, employers, financial markets, and state and local governments totaling up to $2.3 trillion. It recently signaled that rates would remain low for an extended period and that it planned a “highly accommodative” monetary policy.
Government bond interest rates declined sharply in the first quarter, but then have been largely unchanged in the second quarter, with the 10-year Treasury holding steady at around 0.7%. Riskier corporate bonds, however, initially saw interest rates spike up as investors became concerned about credit risk, but then come back down closer to government bond rates after the Fed stepped in. This was particularly striking in high yield bonds which started the year at a 3.5% spread over treasuries, reached a spread of almost 10% in late March, but now have come back down to a little over 6%.
Commodities and Currencies
Gold, like bonds, has been helpful in reducing volatility in the portfolios, and provided an offset when stocks declined most sharply. Gold, the only commodity position held in our portfolios, rose 6.2% in the first quarter, and has gained an additional 9.9% in the second quarter.
Other commodities have done less well – particularly those whose usage is related to economic production. Oil, coal, and natural gas all saw substantial drops and the overall Bloomberg Commodity Index, which tracks 23 commodities, was down approximately 20% year to date through June 30th.
Investors are closely watching COVID-19 data on cases, hospitalization, and deaths. Markets are seeking to ascertain whether a return to lockdown conditions is likely or not. In the end, stock prices depend on corporate earnings and currently analysts are expecting a return to 2019 earnings levels by 2021 – only a one year dip. This may prove overly optimistic, as analyst forecasts often are, but the point remains that markets are continuing to expect this particular earnings decline to be a relatively short-lived one.
At Plum Street Advisors we believe that the best defense against short-term volatility in the markets is properly customized strategic asset allocation. Our balanced portfolios of stocks, bonds, and commodities weathered the recent storm with much less volatility than the global stock market, and that is our goal. We closely monitor current conditions and ensure, on an ongoing basis, that portfolios are taking a level of market risk that is appropriate for each individual client. We also worked hard to increase the frequency of our communication during the crisis to ensure that clients felt informed and in control. We hope no client will ever hesitate to reach out to us with any questions or concerns, as volatility undoubtedly will rear its head again.