What is normal anymore? For May normal turns out to be another good month for investors as the markets continue to recover from the effects of COVID-19. Both US-based equities and global equity indices performed impressively, all up between 3% and more than 8%. The Aggregate Bond Index continued to shine, gaining 0.49% for the month. On the strength of oil prices the commodities index was up more than 8%, though still off substantially from where it started the year. The laggard this month was the US Dollar Index, down 3.15% in May.
U.S. & International Stock Index Returns
|Index May 2020 Year-to-Date|
|Dow Industrials 3.63% (11.06%)|
|S&P 500 4.08% (5.77%)|
|S&P 400 (Midcap) 5.70% (14.50%)|
|S&P 600 (Small Cap) 3.14% (21.35%)|
|MSCI World 4.48% (8.93%)|
|MSCI EAFE 8.12% (15.31%)|
|Bloomberg Agg. Bond 5.47%|
|CRB Commodity Index (28.80%)|
|US Dollar Index 1.83%|
All data as of 06/01/2020, 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.]
Market Mulligan, Market Trap or Something Else?
If on December 31, 2019 we told you that the stock market would see a 30%+ fall in March 2020 due to a global pandemic that essentially shut down the global economy, would you have expected to see the Dow Jones Industrials Average (DJIA) only down 11% by the end of May? Or more amazingly, the S&P 500 off just 5.77%? Very unlikely. The market is an incredible beast which time and time again can fool just about everyone. Then just when you think you have a firm grip on exactly what’s going to happen next … you have to ask yourself what just happened.
As we enter the month of June the investors who stuck it out, who didn’t sell their accounts to cash in fear, are quite relieved with where we are today. Does that mean one should be complacent? Not now, not ever. More to the point, now is a great time to reflect on where we are and what the future looks like.
Like the headline, it is time to ask, did investors just receive the investment mulligan of a lifetime, a market trap, or something else?
Let’s dig in.
What Are the Known Knowns?
This is pretty simple and straightforward. We know that over the past few months the country (and world) has gone through immense turmoil. As we noted in our April Letter, there are four distinct issued that have affected our lives and our investments. They are:
- 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 with a modest rebound in oil prices
- Greatest central bank/government intervention of all time
We also know that both the stock market and the bond markets have stabilized after a 5-week period of great market instability. The stock market moved from all-time highs, to a drop of more than 30%, as the bond market saw credit spreads widen due to a combination of liquidity issues and investor angst. Since the market bottom in mid-March the rebound has been beyond our original expectations.
As we enter June the country is in a much better place. Business is starting to pick up as businesses of all sizes have started to adjust to the new reality. Now that every state in America is in some phase or “reopening” the local economies, business continued to increase for businesses of all sizes.
Unfortunately, there are some companies that simply are not going to make it. Locally we have seen the start of permanent business closings. Some larger companies have already filed for bankruptcy. And according to Moody’s Weekly Outlook dated May 14th, the high yield bond default rate is expected to be greater than 12%. The business destruction has started and will likely continue on for some time.
What Are the Known Unknowns?
For investors, we believe the biggest unknown right now is the reopening of the economy. We know that not all of the jobs will come back and we know that there will likely be more business failures. Beyond that, how this is all going to play out is a bit of a mystery.
The term “new normal” has been tossed around lately to describe what life will look like. Less in-person interactions, more online engagement. Zoom meetings and gatherings are now common. Many of us are more comfortable with curbside pickup of everything, be it a needed tool from a hardware store or Sunday night dinner from the diner. As economic reengagement begins nobody really knows what our world will look like in 6-, 12- or 18-months’ time.
For investors this is an important unknow as the companies we own (either individually or through ETFs and mutual funds) have to adjust to survive and thrive. What we believe is the likely scenario is a wider gap between the companies that thrive and those who struggle. A solid balance sheet along with smart, nimble management teams are key.
Also, of importance, is we don’t know what will happen with COVID-19. Will there be a viable vaccine available by early 2021 as some have speculated/hoped for? If we do have a vaccine, can we produce enough doses to take care of most Americans over a period of months, not years? And if we don’t get a cure for this, does it come back in the Fall as some have speculated, or are we past the point of having to worry about huge negative consequences?
As we open up, how people will react? How much shopping will people be willing or able to do? Will restaurants once again fill with diners? What will overall consumer spending look like?
Finally, what happens to corporate earnings in the coming months and years. We know that second quarter will be about as bad as can be. What we don’t know is what the outlook will be for corporate America for the second half of 2020. Come July we will get guidance during the quarterly calls from publicly traded companies. Unfortunately, CEOs and CFOs are not always correct in their assessment of what their company’s business model will be like in the short term. After a shock to the system like we have just survived we expect the forward expectations to be muted at best, wrong at worst.
Honest truth: there are a lot of questions nobody has an answer for at this time.
Magellan’s View of the Future
Clearly the world will not look like it did 14 months ago. That isn’t necessarily a bad thing or a good thing, it’s just a thing! In many ways what we are experiencing is what the world experiences in a normal economic recession. What is different today is the scale and speed in which it is happening!!!
Good businesses and good business models thrive, coming out of the economic downturn stronger. Bad business, poorly structured businesses, businesses with outdated business models will either fall by the wayside or get bought up and integrated into stronger businesses via corporate buyouts. There are well established technology and health care companies that are made for this moment in time. Retailers are adjusting their sales model with the big likely to get bigger. Great management teams will figure it out.
At the same time, new businesses and business models begin to take shape as the world we live in change. After the Great Recession in 2008 the “gig economy” and the “sharing economy” became the new model for business. Coworking, crowdfunding, house rental and ridesharing are now commonplace. The business shift to the “new normal” is already upon us regardless of your personable ability to see it happening.
The short-term problems may be hard to ignore for many of us but we believe it is important to continue to look to the future with promise and hope. American innovation has never let us down. It may take some time, but in the end we will adjust and the result will be a stronger and more innovative economic future.
What About the Markets?
As we stated at the beginning, the turnaround for the stock market has been quite spectacular. We enter June with markets down modestly, all things considered. The big issue we hear from clients is the disconnect between the real economy and the swift market rebound. Clients and prospects have questioned how this can last.
A fair point for sure.
Warren Buffet famously said that in the short term the stock market is a voting machine, but in the long-run is a weighing machine. His point being that in the short-term markets are emotional and open to irrational moves (both up and down) but over time markets move based on fundamentals (i.e. earnings). The former pretty much sums up what we have experienced here since early March. As long as the news stays positive it is likely the positive stock market trend to continue, at least in the short term.
Something that should be noted is the disconnects we have seen between the stock market as a whole and some of the specific areas of the market. Small and Mid-sized companies have lagged the S&P 500, as have traditional value stocks. At the same time, the healthcare and technology sectors are thriving as many of the companies in these areas have either not been affected by, or are benefitting from the current conditions. One commonality the lagging sectors have is they are more tied to the shutdown of the general economy. In our opinion, a continuation of the positive returns has to involve investors rotating into these beaten down sectors.
Longer-term it comes down to earnings. Expectations for 2020 and 2021 have been lowered to reflect the current state of the world economy. The market will continue to look beyond 2020 and focus on 2021 and 2022. As long as there are no major setbacks, we are positive on the stock market.
One Final and Important Note
While we all have a political point of view, managing people’s retirement savings is not about politics. In fact, when it comes to investment decisions it is best to put your personal politics aside. From the beginnings of our firm as Warren York and Associates in the 1950s to our current form as Magellan Financial, we have always looked at politics from the standpoint of how political decisions effect our client’s investment and retirement savings.
However, it is our belief at Magellan Financial this is not about a political issue or a small percentage of protestors inciting violence or vandalism. Nor is it about choosing sides. It is about basic human decency. It is about recognizing society has a problem that we need to work together to fix.
Sometimes it is hard to believe that we live in the 21st century. It is hard to believe the injustice and racism that members of the black community still face today is real. We at Magellan Financial find this to be wrong and unacceptable. It is fundamental to our society – to the words of our country’s founding documents – that ALL people must be treated with respect, dignity, and humanity.
It is an understatement to say we are outraged by the death of George Floyd and so many others before him. We stand with those who demand justice and systemic change. There is no place in society for racism.
There is lots of work to be done that has been put off for way too long. As a part of that effort Magellan Financial has donated to the NAACP Legal Defense Fund and the National Bailout Fund to help those on the front lines who are making a difference on a daily basis.
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.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
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.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
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Jonathan D. Soden, Managing Partner Jon.Soden@wfafinet.com
Jeffrey T. Bogert, Partner
Robert I Cahill, Partner Rob.Cahill@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com