As we head into the end of the week, the S&P 500 is close to holding a key support level around 2950 in the face of record GDP decline and unemployment. The global economic toll does not lend itself to a story about an only one-month bear market followed by immediate, rapid recovery as we proceed towards large scale re-openings. You can view the current market levels as positive news—the fiscal stimulus and Federal Reserve intervention is working, and the economy will return to some normalcy in short order. Or another possibility, that this narrow exuberance is overly optimistic and markets will crash back to reality when the stimulus effect dies out.
Indeed, looking deeper into the numbers, five firms continue to dominate the S&P 500 returns. Apple, Google, Microsoft, Facebook and Amazon represent 20% of the market value in the 500 stock S&P index. Looking more broadly at global markets there has been recovery, but not nearly as robust as those top five companies. And we have just completed an earnings cycle which included only the beginning of the virus-related shutdown. Small-caps, international developed markets, emerging markets, value stocks and real estate are well beneath their pre-pandemic highs. Bright spots outside of technology may be commodities such as oil and gold. Oil does not come without its risks, but may benefit from extraordinary cooperation, which includes U.S. producers, to limit supply just as demand is starting to pick up. Low production and increasing consumption could help prices recover rather quickly if production remains voluntarily capped.
Is it time to jump back in to equities? The answer is very likely mixed. There has been little economic good news since March. We still do not have a good handle on when and if we will have an effective vaccine or effective therapeutics, and most important, if we will have a significant second wave later this year. We still do not know how the last 2-3 months will change behavior, both in the short term and the long term. We see increasing signs that globalization is under siege with likely negative effects on global growth and cooperation. The relationship with China is becoming increasingly unstable, partly legitimate and partly political opportunism, but there are not many defenders on either side of the political aisle.
We have been adding some risk assets to portfolios in a measured way and will continue to do so. We are being patient not to buy the most expensive stocks that have led this interim rally from the bear market, but are looking to take positions in asset classes which we feel will have a much higher probability of better returns from this point. Any hiccup in the economic recovery narrative will send the market tumbling and it is likely the most expensive assets relative to earnings will get hit the hardest—the same ones that are leading the S&P 500 higher. We believe there is a high probability we will see lower stock prices in the near future.
The bond market literally froze in March with prices for investment grade bonds dropping 10% or more before the Federal Reserve stepped in. This was a striking event as it was a larger decline and disruption to the bond markets than in October 2008. With Federal Reserve intervention, it appears the fixed income market has stabilized enough that we are comfortable moving out of higher levels of short-term treasuries yielding less than 0.5% into diversified managed bond funds. This could help provide modest returns on this part of your portfolio.
After analyzing this week’s closing prices as well as the end of the month next week, we will have a clearer idea on what changes outside of the fixed income holdings we will be making.
We wish everyone an enjoyable and safe Memorial Day weekend!