Q2 2020 Review
- We believe equities have already discounted a great deal of the recovery
- We have been preaching and exhibiting patience with portfolio changes
- We generally remain on the conservative side with above-average levels of cash, a focus on domestic, large-cap equities, and with a distinct tilt toward quality in both equity and fixed income portfolios
The second quarter of 2020 was one that never will be forgotten. COVID-19 caused a global pandemic that led to deaths in more Americans than the wars of Vietnam, Korea, and the Gulf Wars combined, and led to “stay-at-home” mandates that caused a sharp, deep recession in Q2 when nearly 20% of Americans were unemployed.1 In May and early June, after many thought the curve of new coronavirus cases had been successfully flattened, economic reopening occurred across the country. Within weeks the virus spread however, and the US entered the July 4th weekend reporting record numbers of new cases of over 50k/day.1 This is double the rate seen in mid-May with total cases now totaling 2.8m, up from 200k cases at the end of Q1.1 Reopening plans have been rolled back in many states including closures of bars and restaurants, travel bans are in place in many states and preventing Americans from entering Europe. Generally, the level of uncertainty regarding the virus is growing, not falling. A second crisis hit America in Q2 following the death of George Floyd in Minneapolis at the hands of white policemen, leading to national protests, many that erupted into violence, looting and significant property damage. Race relations have reached a tension point that along with continued extreme income inequality, Americans seem as divided as most can remember. Finally, President Trump’s polling numbers fell dramatically in June following the country’s perception of his leadership during the two crises, leading to increased uncertainty in the November election.
Despite this environment, risk assets enjoyed strong rallies throughout the quarter, leading to discussions of the disconnect between Main Street and Wall Street. Backed by massive monetary stimulus from the Federal Reserve, fiscal stimulus from the Treasury, some early success in the reopening and hopes for a vaccine, US stocks had their best quarter since the fourth quarter of 1998.1 US stocks were again led by the large-cap Technology and other popular growth stocks, leading to concerns of narrowing market leadership that has some resemblance to the dot.com period of the late-90’s. After falling 35% in a matter of weeks before bottoming in March, the S&P 500 Index gained 20.5% in the quarter.1 As seen in the table below, growth stocks again sat at or near the top of the performance tables, with many small and large-cap growth indices gaining 30% as new (and old) technologies positioned to thrive in the stay-at-home period rallied – think Zoom (new) and Amazon (old).
Reopening was met with early success as a number of economic indicators were better-than-feared in May and June, including two monthly Nonfarm Payroll reports, as the recent report for June showed unemployment levels falling to 11.3% while 4.8m new jobs were filled.1 Hopes for a V-shaped recovery were also boosted by a strong Retail Sales report in May,1 leading many to believe the sharp recession that occurred in Q2 could be the shortest on record. With some progress reportedly being made on several treatments and potential vaccines, many market participants have started pricing risk assets as if the worst of the virus’ impact is over. This was before the onset of what many are calling the “2nd wave” of new coronavirus cases that occurred in mid-June, and before steps had been taken by many states (including the mandatory wearing of masks in public places in 19 states) to reverse reopening plans, causing many to question the pace of any economic recovery with 20m Americans still unemployed.1 With expectations that the Federal Reserve will do “whatever it takes” to support the economy and risk assets (including the open market purchases of individual bonds and bond ETFs during Q2), investor attention has turned to Congress, as the $600 weekly unemployment benefit from the Federal Government expires on July 31st.1 The passage of another fiscal stimulus bill is an uncertainty entering Q3, but one that is increasingly likely we think.
Fundamentum strategies have largely participated in the market’s recovery, though generally remain on the conservative side with above-average levels of cash, a focus on domestic, large-cap equities, and with a distinct tilt toward quality in both equity and fixed income portfolios. We have been skeptical of the V-shape recovery argument, believing that while there will be a significant recovery from the shutdown induced recession, the ongoing battle against Covid-19 will leave the level of the economy below its potential throughout 2020, and likely through 2021. We believe equities have already discounted a great deal of the recovery that we envision, with the S&P 500 barely down for the year and with tech-heavy indices solidly positive for the year. Bond yields were largely unchanged in the quarter, as the 10-year Treasury Bond finished at 0.65%, down slightly from 0.69% at the end of Q1.1 To us this means the bond market is not seeing quite the same future economic picture that equity markets are. Trading above 3150 at the time of this writing with S&P 500 EPS forecasts in the $125 range for 2020 and $160 for 2021, we see S&P 500 equities as fully valued (at best) and are generally unwilling to bid up equities beyond the already high ~20x multiple on 2021 earnings.1 This is despite record-low interest rates and inflationary pressure that are surprisingly absent given the massive increase in the money supply. Beyond the tax loss harvesting and rebalancing that occurred in Q1, we have been preaching and exhibiting patience with portfolio changes. We acknowledge investors seem willing to look past longer-term concerns that are growing – such as large government deficits, large increases in corporate debt and increasing leverage throughout the system – responding instead to the beneficial aspects of the growing money supply and aggressive stimulus put in place thus far.
The longest-running bull market in history ended in Q1 of 2020 and the shortest-ever recession likely ended in Q2 of this year. Both led to predictable large gains and losses in equities, leaving large-cap US stocks nearly unchanged for the year. While there are still significant losses in small-cap stocks and non-US stocks, equities have largely already discounted a strong recovery, though the discovery of a vaccine is probably still not discounted. This strikes us as very optimistic. Stocks are expensive and risks are higher now than pre-COVID (more debt, less earnings, more uncertainty), but rationally investors have little choice but own equities in a zero-interest rate environment where credit spreads are near record lows. We would expect a sharp rally in stocks should a vaccine be announced in the back half of the year, but short of that, we expect future gains to be modest given the starting point of high valuation. There is more value in non-US equities and the virus seems more contained in many regions outside the US, so additions to those markets are being contemplated as we enter Q3.
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
References: 1. Factset 7/8/20
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.