After one of the worst months for the stock market in March, April came roaring back with strong gains for all the US-based indices we follow, and solid gains for the global stock indexes. That strong performance did not negate all of the March losses, but certainly helped put investors a little more at ease. Commodities continued to slide, losing another 2.47% this month on oil weakness. The US dollar also lost ground in April. Bonds continued to strengthen as yields fell.
U.S. & International Stock Index Returns
|Index April 2020 Year-to-Date|
|Dow Industrials 8.51% (14.69%)|
|S&P 500 10.15% (9.85%)|
|S&P 400 (Midcap) 9.83% (30.03%)|
|S&P 600 (Small Cap) 8.45% (24.49%)|
|MSCI World 8.48% (12.48%)|
|MSCI EAFE 4.81% (18.71%)|
|Bloomberg Agg. Bond 4.98%|
|CRB Commodity Index (36.92%)|
|US Dollar Index 4.98%|
All data as of 05/01/2020, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
Taken out of context April turned out to be a great month for stock market investors. Not only were the equity markets up strong, but bonds and gold were up as well. Taken in context, bonds and gold have performed well in 2020 as the big gains for the stock market this past month were a bounce off the bottom of a quick, painful drop. More to our point, stocks gapped DOWN the most ever in March then gapped UP the most ever in April. Sounds kinda crazy … almost fictional … yet here we are at the start of May trying to understand what this all means.
What About the Economy?
Right now the world and country are in an economic place we have never been before. The country (as well as most of the world) has been economically shuttered due to the COVID-19 pandemic. We are now living through history. There will be books written, an insane amount of analysis, and second guessing about how to best handle this moment in time. Saying this is nothing like anything we have gone through in the last century is not an exaggeration. Consider that right now we are in the middle of:
- One of the greatest pandemics since the Spanish Flu in 1918 (over 100 years ago)
- The greatest economic contraction since the Great Depression in the 1930s (80 years ago)
- The greatest oil price decline in the OPEC era
- Greatest central bank/government intervention of all time
The result of this unique set of events is more than 30 million people unemployed, an official unemployment rate that will likely top 20%, an economic downturn that could be worse than the 1930s with second quarter GDP to contract at a 40% annualized rate (In economist Michael Deroli’s words, the economy as “literally in a free fall”), with corporate profits down in the first and second quarters and are expected to be negative for the year.
According to Howard Marks,
“The future for any and all of these things is unknowable. No reason to believe we know how they’ll operate in the future, or how they will interact with each other, or what the consequences will be for everything else. Given that we are living something that has never been experienced before there is no way to know how it will turn out.”
Yet, even as we are not able to know the future, that doesn’t keep us from reaching conclusions we deeply believe in. “The reopening of the economy is likely to be gradual and, until a vaccine is perfected or heard immunity is reached, subject to alternating periods of progress and retreat.”
The above is because people will not simply be going back to what life was like just a few months ago. Ask yourself, when will I get back onto an airplane? Are you ready to go back to work? What if a colleague gets nasally starts to cough because of allergies? What about going to a restaurant or a high school football game? (Source)
In other words, when the world “opens up” again it will be a different place from the one we were in just a few months ago. In an April 20th interview on The Daily podcast, NYT science and health reporter Donald G. McNeil, Jr. argued it is highly unlikely that we will be getting back to “normal” anytime soon. Talking to experts he concludes that a more reasonable timeframe for the old normal is 2022 or 2023. Why? The need for a vaccine and the reality that the fastest a vaccine has ever been developed is 4 years. Even with a fast vaccine solution, current production capacity is far from the demand for the solution. We need to be working on the ability to scale up production now so we are ready when we do finally have a vaccine ready for use.
The good news is that it is very likely a vaccine can be produced much faster than it has in the past as a large amount of global resources are working with a wide array of research teams for a solution. Moreover, the Trump Administration’s Operation Warp Speed currently has HHS actively searching for US-based production solutions that will allow for mass producing a vaccine once it is found.
What About the Markets?
The past few months have seen historic levels of volatility in the stock market as well as displacement in the bond and commodity markets. To the surprise of many, those who did not panic sell have managed to be OK. Yes, the Dow and S&P500 fell some 35% from their all-time highs in late February. Yet here we stand down 10-15% YTD but only down some 2% from a year ago. Considering everything that has happened in the past few months, things could be a whole lot worse.
In our opinion, the unprecedented $3 trillion stimulus from The Fed combined with the fiscal stimulus dampened the pain for investors. Wall Street is not Main Street, or so the saying goes. What’s happening in your life is not necessarily reflected in stock prices as the S&P 500 is not representative of the broader economy. And what is happening with the broad index does not necessarily mean the average company (stock) is doing well. There are times when the “stock market” moves as a result of many companies and sectors doing well, other times it moves as a result of what is happening with a few companies.
Right now the average stock is lagging the broader index. How do we know this? The S&P500 is a cap weighted index, meaning the largest companies hold a greater weighting than the smaller companies do. By comparing the index to an equally weighted version it is possible to see how the average stock is doing relative to the overall index.
Chart #1 is a ratio chart of the S&P500 Index to the Equal Weight S&P500 Index. When the line is moving higher the S&P500 is outperforming and when it is falling the equal weighted version is outperforming. Over the past few years the S&P500 has generally performed better. Since the beginning of the year that outperformance has increased substantially. The market has been moving higher on the strength of very few individual stock names – think the largest of the mega-cap stocks – while important sectors lag (Financials, Energy). Weakness can also be seen in the thrashing the S&P 400 (midcap) and S&P 600 (small cap) indexes have taken in 2020.
This phenomenon tends to be cyclical and smaller companies will eventually start to outperform the largest of the large caps – assuming it’s not different this time.
Chart #2 below depicts the Dow Industrials ($INDU) with the Fibonacci retracement levels we are looking at. We find it unsurprising the market has lost some steam here. How it reacts from here going forward it the real question.
You can find an explanation of Fibonacci retracements and ratios here.
The broader weakness can also be seen in the number of stocks trading above their 200-day moving average. Currently this number is getting better – just under 17%. This is interpreted as less than 17% of stocks are bullish as 83% are in a bearish trend. Needless to say, these numbers are constructive but not great.
What Does this mean for Investors?
“Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names” – Bob Farrell (Technical Analyst)
We would not use the word strong to describe the stock market at this juncture. Yet we don’t believe equity prices are heading back to the March lows. For the immediate we see a market in flux; a market waiting for some direction. It is possible we could be on the verge of a major move lower or a major move higher. In our opinion a chart is not going to tell us which direction of the next big move. No.
The next big move will likely be a result of what happens in the world. The next big move will likely happen quickly and suddenly. The next big move will likely be a result of how investors perceive what happens next.
In the end we truly believe that investors who don’t panic will be rewarded. But let’s not pretend this will likely be a smooth ride. Volatility probably will not go away anytime soon. But over time, we know the big moves lower should reverse and the stock market eventually got to new all-time highs. It has happened EVERY. SINGLE. TIME.
In the current situation we believe we will need to see a solution to the pandemic that allows society to get back on the path to normalization. We discussed this in our March 2020 Market Review. It is unlikely to be a direct path back to prosperity. The Fed has put a floor under the markets with liquidity. That means we see the likelihood of a strong move lower to be possible, not probable. The bear market may be social distancing right now. Doesn’t mean the bear market is yet a thing of the past.
Based on what we know right now we see the most likely scenario to be a stock market that is range bound with strong moves up and down based on news. A positive report on a possible vaccine should cause a rally. We believe a setback with “reopening the country” would cause investor pain.
The bear market in US stocks was born of the coronavirus pandemic. It caught a lot of people off guard. Even some of the brightest minds on Wall Street. We believe it will end when a suitable solution is found that allows for a path back to a more normal economy.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
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Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
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Robert I Cahill, Managing Partner Rob.Cahill@wfafinet.com
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