The second quarter of 2020 will make history as will the first quarter albeit for different reasons. As we all painfully remember the Q1 marked nearly unprecedented volatility in the markets as the world dealt with the unfolding news of Covid-19. The S&P 500 plummeted to its lowest when it fell 33% from its high in less than 5 weeks.
Beginning near the end of Q1 and sprinting straight through Q2 the market has come roaring back. Below is the performance of major indexes in Q1 vs. Q2.
As you can see the market roared back this past quarter. Small Cap U.S. stocks lead the way after being beat up the worst in the first quarter. In the market update presentation Mark Carter and I did on March 20, we expressed optimism for a quick recovery but to be honest, the velocity of this market rebound is greater than most investment professionals (including us) anticipated. This leads us to the discussion about the two economies.
Is The Market Delusional?
As we stand today, the unemployment rate is still over 10%, many businesses are still closed or operating at limited capacity, and some states are seeing a surge in Covid-19 cases raising the fear of a second shutdown. Additionally, I fear many small businesses such as restaurants and gyms have closed and will never reopen. Despite all these headwinds, markets have rallied and on a first look might seem bizarre since the stock market and the economy are normally moving in lockstep. We wouldn’t blame you if you were to ask if the market is delusional.
First, we must understand that the market is forward-looking. The roughly 11% unemployment rate we are currently experiencing is certainly better than the 14% rate we saw back in April. If that trend continues as the market perhaps expects, the economy will continue to improve and therefore justify higher stock prices.
Second, the unprecedented fiscal and monetary policy that Congress and The Fed have implemented has certainly buoyed stocks. The Fed has seemingly committed to doing whatever is necessary to ensure a speedy recovery. This gives us long term concern with regards to ballooning deficits but that is another issue altogether.
Third, optimism for vaccines and treatments has reinforced confidence in the market on days where there is positive news concerning a vaccine. I’m admittedly not an expert on anything medical, but the experts seem to have optimism that a vaccine will be ready in early 2021 and that the medical industry is getting better at treating Covid patients. There is evidence of this as the death rate has been steadily decreasing even among older patients.
Last, pent up demand has created a spending surge in certain industries. Companies like Amazon, Home Depot, and Target have reported better than expected sales considering the Covid conditions. This could mean a variety of things. However, my take is that due to pent up demand combined with the monetary stimulus (including unemployment bonuses) consumers are ready to spend.
Although the factors above might explain why the market has rallied so drastically, it does not necessarily mean that the market is correct. It is our view that markets overreact on the down and upside. There are significant risks still facing the economy and the market. For example, Illinois, New York, and California make up nearly 27% of the U.S. economy. If Illinois and New York decide to shut down (as California already has) that will have a significant impact on the economy.
With that being said, the economy has been resilient thus far and with more monetary stimulus on the way this rally could very well continue. Additionally, the rally has been (to some degree) very narrow meaning that not all sectors of the market have recovered. Take for example the Dow Jones vs. the Nasdaq. Dow Jones contains many large “old economy” companies such as Johnson & Johnson, Walmart and Proctor & Gamble. The Dow has significantly under performed the Nasdaq (year to date) which is more heavily weighted towards tech companies such as Apple, Microsoft, Amazon and Google.
As the third quarter unfolds, we will be keeping a close eye on the economic recovery as well as market valuations. In our view, there are sectors of the market that are currently overvalued and it may be that risk outweighs reward in the short term which is ok because we are long term investors. As we look toward the longer term, we expect all sectors of the market to recover well before the economy as a whole. By next quarter, the election cycle will be heating up and talk should be turning to what the odds are of a Biden presidency and which candidate will be better for the economy.
This commentary on this website reflects the personal opinions, viewpoints and analyses of the Financial Strategies Group, Inc employees providing such comments, and should not be regarded as a description of advisory services provided by Financial Strategies Group, Inc or performance returns of any Financial Strategies Group, Inc Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Financial Strategies Group, Inc manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Written by Brice Carter.