Weekly Snapshot June 12th, 2020
Market Review: Week Ending 6/12/2020
In a week that saw the S&P 500 Index return to positive territory for the year and oil prices touch $40 after being below zero for a day, the Index ended up falling 4.8% to 3041, the worst week since the week of March 20th.1 The Index fell 6.9% on Thursday, the day after Fed Chairman Powell’s more measured view of the reopening outlook (forecasted 9.3% unemployment at year-end1). Thursday was also when the narrative around the chances for a virus’ 2nd-wave changed, as it’s now being widely reported that 22 mostly southern states have seen sizable increases in the number of cases after their reopening (not due to increased testing), with a few warning of hospital shortages.1 This followed two weeks of bullish sentiment about a “V-shaped” recovery after the May payroll report, a time that saw many left-for-dead stocks rally 50-100%, leaving the overall market extremely overbought. Growth stocks and Covid-19 winning Technology stocks held up better last week, as the NASDAQ Index declined only 2.0% while the riskier Russell 2000 Small-Cap Index declined 7.9%.1 10-year Treasury Bond yields fell 20bps last week, closing at 0.71%, following the more guarded view taken by the Fed on the pace of the recovery.1 But, recovery will and is happening as states reopen. Apple’s mobility index, for example, shows driving queries up substantially, airlines and Airbnb are reporting increases in bookings and restaurants reservations are now down 60% y/y according to OpenTable, compared to virtually 100% y/y in March/April1. At Fundamentum, the primary questions remain the same; 1) What is already being discounted with the S&P at 3041 and 2) What level of the previous output will be achieved, 80%? 90%? When will the previous economic output be surpassed, 2021, 2022? We also remained concerned about the large and growing debt levels in the Government and Corporate sectors. Government debt has gone from 110% of GDP following the Financial Crisis to 186% today,1 and the WSJ reports that over 200 companies in the S&P 500 Index have higher interest cost than EBITDA at a time when interest rates are at historically low levels.1 Should rates ever increase, servicing that debt will become a front-page issue in our view. Massive stimulus softens these worries in the short-run, but our managed portfolios remain with a conservative bent – slightly underweight equities (US Large-Cap overweight), below-average duration with a focus on Investment Grade within Fixed Income, and with cash levels above the midpoint of our neutral benchmarks. Through the close Friday, year to date results for the major indices are as follows: S&P 500 -5%, Russell 2000 -16.3%, MSCI EAFE –12.1% and Bloomberg Barclays Aggregate Bond 5.7%.2
What We’re Watching in the Week Ahead
- Virus/Reopening/Social Unrest – The US is fighting record-high unemployment, social unrest over police brutality and a continued health care crisis as evidence mounts of rising Covid-19 cases after the reopening. The direction that these three conditions head over the summer are expected to be large factors in the pace and magnitude of the recovery following the reopening, before investor attention turns to the Presidential election in November.
- Valuation – Stocks typically sell at a discount to normal valuation levels during uncertain times. This time, we believe the uncertainty of where earnings will bottom during a once-in a-lifetime pandemic, has contributed to the rally in stocks. Rather than debate whether stocks are already discounting the improvements expected from an economy that is re-opening, without company guidance or any history of outcomes during a pandemic, valuation has effectively been eliminated from consideration. We do know that 2019 S&P 500 EPS were $1651. What we do not know is what level the economy (and earnings) will recover to – 80% of the previous level? 90%? 100%? And when? It will take many months to answer the question about the level of earnings likely in 2021 (the Congressional Budget Office revised its 10-year economic forecast, projecting that the U.S. economy would require the entire decade to make up for output lost in the pandemic). Until then, investors have largely eliminated high multiples as a reason for stocks to pause. We have been skeptical that stocks could go rally beyond 3000 on the S&P 500 as we’ve been assuming $150 for “normalized EPS,” and willing to assign a 20x PE multiple during this time of extraordinarily low interest rates. Without considering the question of valuation, stocks have rallied beyond that level without pause (until last week).
- Economic Reports – Retail Sales and Industrial Production reports for May will be released this week, giving investors another look into reopening progress for hard-hit sectors. Housing Starts and Weekly Jobless claims will also be released, and both are expected to continue positive trends seen from the depths of the lockdown.
As always, we appreciate your confidence in our team.
Fundamentum Investment Committee
Chad Roope, CFA® Portfolio Manager
Paul Danes, CFA® – Investment Committee
Trevor Forbes – Investment Committee
Matt Dunn, CFA® – Chief Compliance Officer
1-Morningstar Direct 6/15/20
Investment advice offered through Fundamentum LLC a registered investment advisor. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the investment objective of any investment strategy will be attained. Investing involves risk including loss of principal. Past performance is no guarantee of future performance. All indices are unmanaged and may not be invested into directly.