We are now at the beginning of the third quarter, and 2020 will forever be known as the year that the COVID-19 pandemic struck. It has been the reason for government induced recessions, extreme market gyrations and, ultimately, illness and death on a worldwide scale. Global economies are facing a wide range of consequences from the pandemic. There are some economic segments that made out very handsomely, while others have been devasted.
Much of our work is tailored around evaluating the current economic climate, and in this way, we can adjust our investment strategies moving forward. The pandemic has created some economic flux, as such, we are reviewing a wider range of aspects in the global economies. We have listed key bullet-points below to paint the picture of the current economic environment.
The Global Economies:
- The economies of the world have been severely impacted by COVID-19, with government mandated business shutdowns and people sheltering at home.
- U.S. Leading Economic Index (LEI) increased 2.0% in June following a 3.2% increase in May. Coincident Economic Index (CEI) increased 2.5% following a 1.6% increase in May. Lagging Economic Index (LAG) fell 2.5% in June after a 1.2% decrease in May. These indices are suggesting that the U.S. economy is recovering, albeit in the early stages, from the recession.
- GDP Growth projections for 2020 in the U.S. and world advanced economies are around –8.0%. The growth projections for 2021 in the U.S are 4.5%, while the world advanced economies are 4.8% (IMF estimates).
- China’s GDP suffered a -6% decline in the first quarter, but in an impressive reversal, rebounded 3.2% in the second quarter (YOY).
- The Eurozone, like the U.S., has gone through a major economic contraction. In response, the European Union announced a major recovery plan. On July 21st, they agreed to a €1.8 trillion ($2.06 trillion) spending package.
- The global economies are showing some resurgence with the re-openings of business.
- The Fed has lowered their funds rate to zero (0.0-0.25%), and current statements indicate that rates will remain unchanged for the foreseeable future.
- On the domestic fiscal side, the CARES program injected approximately $2 trillion into the economy, the largest stimulus package in U.S. history. Additionally, Congress is seeking to create another stimulus injection in the weeks ahead.
- Inflation is expected to remain very low for the next several years. With low inflation, there is little need for the Fed to increase rates for the next few years.
- Unemployment skyrocketed to over 14.7% in response to the “shelter in place” mandates. The Labor Department reported that the total number of people on unemployment was 31.8 million (reported from the week ending July 4th). The unemployment rate has subsequently fallen to 11.1% in June as businesses have been re-opening.
- With such high unemployment figures, consumer demand has dropped off, and inflation has been non-existent. Inflation in 2020 is expected to be around 0.6%. Likewise, the Eurozone inflation dropped to 0.1% as prices for goods dropped dramatically.
- Oil prices (WTI) were a little over $16 per barrel (spot price) in late April reflecting the reduction in demand and the conflict between Saudi Arabia and Russia. Futures prices were in such disarray that for the first time ever prices went negative for a short period in late April. Tensions have eased, and oil prices have rebounded from the lows to over $40 per barrel.
- Preliminary results from the University of Michigan consumer sentiment survey indicates that the consumers’ confidence is being challenged with the recent upswing in Coronavirus statistics.
- On the political side, this is a presidential election year. As usual, all House members are up for re-election while the Senate will have 35 members up for re-election (1/3rd of the senate plus two special elections in AZ and GA). There are still conventions by both parties to be done, and much political maneuvering to decide on the federal and state governance into the future.
The Global Stock and Bond Markets
- U.S. large-cap stocks were the global winner in the developed markets of the world in 2020. The S&P 500 turned in a nice rebound for the 2nd quarter with a 20.5% increase, its best quarterly gain since 1998.
- The current estimates for S&P 500 earnings & P/E ratios:
- 2020 future earnings estimate $120: P/E 27.0 (Compared to 2019 actual earnings of $67)
- 2021 future earnings estimate $150: P/E 21.6
- 2022 future earnings estimate $175: P/E 18.5
- Considering the Coronavirus pandemic, the S&P 500 future earnings above are a best guess by stock analysts.
- U.S. small cap stocks (Russell 2000) rebounded in the 2nd quarter turning in a 25.4% return. However, over the last 12 months small caps were down -6.6%.
- European stocks (MSCI Europe) decreased -12.8% on a year-to-date basis. EU stocks rebounded in the second quarter on the hopes of an economic stimulus package.
- The sector winners in the 2nd quarter were energy, technology & gold mining.
- Precious Metals (XAU – Gold Mining Index) turned in stellar performance with a gain of 20.8% YTD, and 53.5% over the last twelve months (ending June 30, 2020). The price of gold bullion has been pushed to new highs during the pandemic.
- Oil Stocks (XOI – Oil Stocks Index) declined dramatically in the first quarter reflecting the collapse in demand globally as well as the conflict between Saudi Arabia and Russia. Prices have since rebounded 59.7% since the March 23rd lows.
- Technology (Dow Jones US Technology) stocks turned in stellar performance in the second quarter with a 31.9% gain and are up 37.5% over the last twelve months.
Fixed Income & Cash
- Interest rates have declined since the beginning of the year in response to the Fed’s accommodative stance. A year ago, 1-month T-Bills were yielding 2.2%, and are now yielding only 0.1%. As a result, most money market fund yields have dropped to almost zero.
- Long-term bonds did very well as the Fed injected monies into all segments of the bond market. With Fed policy pushing rates downs, long-term rates declined around 1.3%, resulting in gains to bonds. The long bonds (ICE U.S. Treasury +20 Year Bond) returned an amazing 21.6% year-to-date and was up 26.0% over the last twelve months.
The FPC Team’s Insights & Perspective:
- The first quarter of 2020 was indicative of a fast and severe bear market. In the second quarter of 2020, the markets reversed and went up in an equally resounding fashion. This was a record setting bear market followed by a record setting bull market. However, it was more analogous to a stock market correction on steroids.
- With both fiscal and monetary policy on board throughout the world, equities are the best asset category to invest in. Bonds have reduced their appreciation potential, while cash yield rates have lowered to effectively zero.
- Central banks have lowered interest rates, and governments are creating stimulus to pick up their economies.
- There are various sectors of the market that have been bludgeoned by the pandemic. A few examples: cruise ship industries, airlines, retail firms, hospitality industries, and others.
- Conversely, some industries have benefited: pharmaceuticals, online meeting spaces, delivery services, school software, digital entertainment and others.
- This is an election year and politics can make for wild gyrations in the stock and bond markets.
The FPC Outlook
It is our belief that the major developed countries of the world have moved swiftly through the economic cycle as a function of government mandated shutdowns and “shelter in place” restrictions. The result has been government mandated recessions across the world. The speed with which the economies transitioned to a recession is staggering, bypassing all the normal ebb and flow conditions (waypoints) of a normal economic cycle (see The Economic Cycle chart that follows).
We now find ourselves on the tail end of a recession and in the recovery phase of the economic cycle (between waypoint 7 & 1). The world economies have hopscotched across the normal economic cycle in roughly 30 days.
At this point in the cycle, the economy is characterized by low interest rates, high unemployment, and negative GDP. It is also a time for the beginnings of a bull market in stocks and bonds. With plenty of stimulus to go around, everyone has expectations of better times ahead.
The Economic Cycle
So, what is our view to the future? The economies have improved dramatically since the re-openings of businesses, and unemployment has dropped from its highs. There is a tremendous amount of both fiscal and monetary stimulus that has been injected into the economies of the world. The market(s) have seen a dramatic rise from the March 23rd low. Since then, the S&P 500 has jumped 38.6% by the end of the 2nd quarter and is up a total of 43.7% (July 24th). This has been a nice bull market run.
Against that backdrop, market valuations are clearly on the expensive side. Accordingly, we are reducing our equity holdings in general. In addition, as international valuations are more attractive than domestic markets, we are shifting some of the U.S. allocations to the Eurozone and Asian asset classes.