Top Weekly Themes
- Coronavirus cases are on the rise in several states – Recent headlines revealed a rising number of COVID-19 virus cases across several U.S. states, including Texas, California, and Arizona. The number of hospitalizations and fatalities have fallen considerably over the past couple of months. However, at this juncture, it does not appear that the coronavirus is “seasonal,” which means an abrupt decline in cases during the summer months commonly found with most flu strains. Fear that rising cases could delay the reopening of the economy, especially across several large states, is a fact to which the market is beginning to pay attention. We have said in the past that the market has been arguably a little overly optimistic about the prospects for the economy, given that there is still considerable uncertainty surrounding the coronavirus. A few data points are not necessarily indicative of a persistent trend, but the potential for periodic spikes in cases could make the economic road to recovery more arduous than what is being reflected by the significant rise in equity markets over the past three months.
- Economic data continues to improve with no unexpected surprises – Purchasing Managers’ Index (PMI) data released by IHS Markit continued to show improvements in both the services and manufacturing sectors of the economy. However, the figures still signify an economic contraction. Housing data, such as New Home Sales, Existing Home Sales, and Building Permits showed a remarkable improvement relative to a month ago and provides some comfort that U.S. consumers are not reluctant to spend on large ticket items. Claims for unemployment insurance, both initial and existing, have continued to fall, but are still quite elevated in comparison to levels seen in previous economic contractions. Our basic takeaway from the economic data is that conditions have clearly improved, but we haven’t seen anything that leads us to believe that a V-shaped recovery is a foregone conclusion. We have no changes to report in terms of how we are positioned across different asset classes.
- Equity markets have been consolidating for the month of June – The S&P 500 Index rose approximately 37% from the March 23 low through the end of May, but has been range-bound since. With more than 90% of stocks trading above their respective 50-day moving averages at the beginning of June, a clear sign of the strength of the rally, it is not too surprising that stocks are taking a pause before establishing a new trend. Investor sentiment indicators, such as the Investors Intelligence Bull/Bear Ratio and the CBOE Put/Call Ratio, clearly indicate that many investors have gotten a lot more bullish over the past few weeks. An argument can be made that there is an element of complacency in the market. Looking out further, there is some reason for optimism. There have been five occasions when the market has rallied more than 25% over a 3-month period during the past 50 years. Subsequent returns over the following 12-months have been above long-term historical averages during each of these periods. Encouragingly, factor performance since the March low (i.e., high vs. low beta, small cap vs. large caps, high quality vs. low quality) has resembled the pattern coming out of other market lows over the past 25 years.[1] While there is ample evidence to support the premise that the market has reached a durable low, we think the unique economic shock resulting from coronavirus makes additional market volatility very likely in the coming months.
[1] Strategas Securities, LLC: Technical Strategy – Daily Report June 25, 2020
Returns Table
| Equities | Week (%) | YTD (%) | 1-Year (%) | 3-Year (%) | 5-Year (%) | Div Yield (%) |
|---|---|---|---|---|---|---|
| S&P 500 | (1.0) | (3.6 | 7.8 | 34.2 | 62.5 | 1.9 |
| Russell 1000 Value | (2.8) | (16.8) | (8.6) | 5.2 | 22.5 | 3.03 |
| Russell 1000 Growth | 0.3 | 9.3 | 23.9 | 65.2 | 104.0 | 1.05 |
| Russell 2000 | (1.0) | (14.7) | (5.7) | 4.1 | 18.2 | 1.59 |
| MSCI EAFE | (1.1) | (11.1) | (4.5) | 3.65 | 9.3 | 2.85* |
| MSCI EM (Emerging Markets) | 1.0 | (8.9) | (1.2 | 8.0 | 16.6 | 2.84* |
| Fixed Income | Week | YTD | 1-Year | 3-Year | 5-Year | Yield |
| Bloomberg Barclays US Aggregate | 0.0 | 5.9 | 8.6 | 15.9 | 23.5 | 1.30 |
| Bloomberg Barclays US High Yield – Corporate | (0.9) | (3.1) | 0.8 | 11.4 | 26.5 | 6.68 |
| Bloomberg Barclays Municipal Bond | 0.2 | 2.0 | 4.4 | 12.5 | 21.4 | 1.51 |
| Bloomberg Barclays Global Aggregate x US (Country) | 0.0 | 1.1 | 1.4 | 8.8 | 16.8 | 0.78 |
| Commodities | Week | YTD | 1-Year | 3-Year | 5-Year | Current Level |
| Crude Oil WTI (NYM $/bbl) Continuous | (0.3) | (36.6) | (33.0) | (10.0) | (35.1) | 38.7 |
| Natural Gas (NYM $/mmbtu) Continuous | (5.6) | (29.4) | (32.4) | (47.2) | (46.1) | 1.5 |
| Gold NYMEX Near Term ($/ozt) | 2.2 | 16.0 | 24.5 | 40.3 | 50.4 | 1,762.1 |
| Copper Cash Official LME ($/mt) | 1.4 | (4.5) | (1.8) | 1.8 | 2.9 | 5,880.5 |
| Currencies | 1 Week Ago | YTD | 1-Year Ago | 3-Years Ago | 5-Years Ago | Current Level |
| U.S. Dollar per Euro | 1.12 | 1.12 | 1.14 | 1.12 | 1.12 | 1.12 |
| Japanese Yen per U.S. Dollar | 106.77 | 108.68 | 106.96 | 111.28 | 123.70 | 107.19 |
| U.S. Dollar per British Pounds | 1.24 | 1.32 | 1.27 | 1.27 | 1.57 | 1.24 |
As of June 25, 2020 (close)
*Dividend Yield For MSCI EAFE and MSCI EM are from 5/29/2020.
Chart of the Week
Returns May 1 – June 25, 2020
Key Takeaways
- As you can see from the chart above, more volatile equities, such as cyclicals (Energy, Materials, Financials), small caps, and the highest beta segment of the S&P 500 Index rose dramatically during the first several days in June and have languished ever since. Energy and bank stocks have fallen more than 20% off their June 2020 highs, although Energy is still the top performing sector (+57%) coming off the March 2020 lows.
- These economically sensitive areas are often more affected by headlines surrounding COVID-19, as might be expected. The underperformance of this area of the market coupled with a modest increase in high-yield credit spreads over the past couple of weeks are developments that warrant our attention. Small caps, banks, and energy stocks are still trading below their respective 200-day moving averages, a key technical level monitored by investors. We would like to see these areas cross above this threshold before concluding that the economy is transitioning from contraction to expansion.
- With our tilt towards value equities and overweight position to small caps, we are by default taking on more cyclical exposure relative to our benchmark. The Russell 2000 Value Index, a proxy for small cap value, has roughly 30% exposure to Energy and Financials compared to 14% for the Russell 1000 Index, a proxy for large cap. On the opposite end of the spectrum, Tech and Communication Services comprise 37% of the Russell 1000 compared to just 13% for the Russell 2000 Value. We continue to believe that the extreme relative cheapness and economic sensitivity of asset classes like small cap and value will be beneficial to performance once a true recovery takes hold. Although we are skeptical that a robust recovery is imminent, we also know that once the recovery becomes clear, markets will have already moved. Therefore, we maintain our cyclical exposure tilts, while at the same time managing near-term risk by recommending a small underweight to overall equity targets.
Commentary
The Federal Reserve Releases Stress Test Result for the Selective Banks
Last Thursday, the Federal Reserve (“Fed”) released its annual stress test results for the largest 33 U.S. banks as stipulated by the Dodd-Frank Act. Aside from the typical stress test, this year the Fed also conducted a special “sensitivity analysis”, which incorporated more dire economic conditions resulting from the COVID-19 virus fallout. For example, the Fed conducted its analysis of banks assuming either a V-shaped, U-shaped, or W-shaped recovery while incorporating more significant peak-to-trough declines for both the economic growth and unemployment rates compared to previous reviews. Also, the impact of fiscal policy, such as the CARES Act, was not factored into the study that was performed.
A positive takeaway is that the Fed indicated that all large banks are sufficiently capitalized, and specified that the banking sector has been a beacon as the economy rapidly deteriorated. However, the Fed announced the following measures that will take effect during the third quarter of 2020, to ensure banks continue to be well-capitalized: 1) share buybacks will be suspended, 2) dividend payments will be limited and based on net income levels, 3) banks will be required to re-assess capital needs later in the year, and 4) additional stress test analysis will be performed by the Fed later in the year. These restrictions, combined with the fact that the Fed did not release specific details about individual banks, unlike conventional stress tests, are likely a net negative for bank share prices. That said, depressed valuations for bank stocks likely already reflects at least some of these headwinds.
We will continue to review each of our bank holdings across the strategies we manage to determine if any adjustments are warranted.
