Commentary

We reiterate our belief from our last blog that the Covid-19 pandemic is on the wane in the U.S. based on the decline in national and state Covid-19 hospitalization figures that we continue to monitor. As a reminder, we focus on hospitalizations as a leading indicator of future deaths associated with Covid-19. Hospitalization rates across the U.S. continue to decline and totals in the three “hot” states of California, Florida and Texas are no exception. Given that these three states account for ~ 50% of the daily U.S. deaths over the past few weeks this is important. With fewer deaths at the state and national level, we believe that elected officials will gain more latitude to further open local and state economies. In turn, this could lead to a rotation in the U.S. equity market to “reopening” stocks from the “work from home” stocks.

We all may be tired of hearing about Covid-19 but it remains important to monitor as we believe it continues to drive the direction of incremental dollars in the marketplace, specifically the ongoing appetite for “work from home” stocks in lieu of the more cyclically oriented “reopening” stocks. We decided to take a deeper dive into the Covid-19 situation and how the “second wave” in several states (TX, CA, FL) is now playing out. Our conclusion is encouraging given that the three states appear to be experiencing drastically lower hospitalization rates in their respective “hot spots” which should eventually result in lower mortality numbers for the U.S. overall. In turn, this could provide the opportunity for beleaguered sectors to return to more normal levels of economic activity.

Since March, the US stock market has enjoyed a 20% bounce from its bottom seemingly on the vague promise that the US economy was going to re-open and life would resume somewhat normally.  To a subset of investors, the notion of recovery has seemed preposterous as the economic damage inflicted by COVID-19 has been so large, so unprecedented and to a great extent not fully digested by the overall economy today.   A second COVID wave, unemployment, commercial real estate, municipal finances, consumer spending, et al, are at the top of their very long worry list.

This Too Shall Pass….But When? It is very hard to believe that 60 short days ago, the US economy was humming; we were at full employment, consumer confidence was high, interest rates were low, and the stock market had hit all time highs.  The sky was the limit.  Investors were bidding up new economy stocks and all looked good.  And then along came the coronavirus and we all know what happened and we won’t bore you recounting the details of what has been recounted a million times in the media and financial press.

  No sooner than we had published our optimistic outlook for economies and markets did investors experience a somewhat existential event with Friday’s US missile strike, killing Iranian’s military leader Qasen Soleimani. In as much as this event could catalyze into a greater near-term conflict between the US and Iran and more general Middle Eastern strife, we do not believe this will ultimately have a meaningful impact on the global economy...

Despite fears over declining economic growth, a multitude of trade war scares and endless political bickering, 2019 has proven to be a terrific year for investors as the US stock market posted its highest returns since 2013.  And it wasn’t just US equities; bonds, non-US stocks, gold, etc. all posted extraordinary returns at lower and lower levels of risk.  Risk adjusted returns were off the charts.  To quote Frank Sinatra, it was a very good year.

Taking its cue from the previous three months, markets again proved to be increasingly volatile for investors over the course of the most recent quarter.  Market returns were mixed over the entire three-month period but, in general, risk off assets outperformed.  Most notable was the performance of US Treasury securities (the ultimate risk off asset).  For the quarter, yields declined on 30-year Treasury bonds by roughly 40bps, closing the quarter at 2.1%.  During August, the 30-year bond yield hit its all-time low of 1.95%, reflecting increasing concern over US – China trade negotiations and the potential for associated economic deterioration.  As a result, total returns on long bonds for the quarter exceeded 8%!  In fact, when we look across the investment spectrum at a series of higher risk/lower risk investable choices, in virtually every instance, lower risk proved to be the superior performing investment during the quarter. 

Although equities and equity markets tend to get the bulk of the average investor’s attention, the most remarkable thing that has transpired across the economic spectrum over the past ten years has been the sharp decline in government bond interest rates to levels never seen before in the history of capitalism.  Whether driven by persistently low inflation, central bank policy, aging demographics or general economic weakness and risk aversion, interest rates have fallen across the world to the point where negative yields are a somewhat common phenomenon.

The resiliency of the US equity market again was evident in the second quarter of 2019.  The trade concerns of May faded quickly and the market rallied as the Federal Reserve and the European Central Bank both indicated easier monetary policy may be forthcoming.  For the three-month period ended June 30th, the US stock market rose over 4% and has now entirely recovered all of the fourth quarter 2018 drawdown.  The S&P 500 now sits near all-time highs.  And it wasn’t just the stock market.  US bonds also posted extraordinary gains too, confounding the interest rate normalization crowd.  The US 10-year note yields approximately 2% currently, down 50bps in the last 6 months.  The total return of the Bloomberg Barclays Aggregate Bond Index exceeds 6% for the year, which is quite remarkable.  However, not all investors participated in this recent rally as virtually all other asset classes underperformed US large cap stocks and US fixed income, some by a material amount.  This recent rally has truly been highly focused between US Large Cap and Fixed Income.

So, it’s safe to say, the market was very disappointed by the Fed’s 25 basis points tightening yesterday as well as the guidance provided for future hikes in 2019.  Reading the FOMC minutes from November and listening to Fed Chairmen Powell’s remarks at his speech at the Economic Club of New York a few weeks ago, where he said, “We will be paying close attention to what incoming economic and financial data are telling us” many market participants were led to believe that the Fed’s next actions would be more dovish.  That did not prove to be the case.