Recent Developments: Beginning in mid-March, economic activity fell at an unprecedented speed in response to the outbreak of Covid-19 and the measures taken to control its spread. Even after the unexpectedly positive May employment report, nearly 20 million jobs net have been lost since February, and the unemployment rate was 11.1 % as of June 30, 2020.
Real GDP contracted by 5% annualized in the first quarter. The decline in real GDP in the second quarter is likely to be the most severe on record. Recently, indicators have pointed to stabilization in economic activity, and in some areas a modest rebound. With an easing of restrictions on mobility and commerce and the extension of federal loans and grants, some businesses have reopened, while stimulus checks and unemployment benefits have supported household incomes and spending. That said, the levels of economic output and employment have remained far below their pre-pandemic levels, and significant uncertainty remains about the timing and strength of the future recovery. Much of the economic unknown has stemmed from uncertainty about the path of the virus and the effectiveness of the measures to contain it.
Outlook: Economic recovery is likely to be uneven across industries and uncertainty elevated in the absence of a coronavirus vaccine. This is likely to slow the pace of the rebound after the initial jump in growth due to the limited reopening. As a result, the level of real GDP probably will remain below its pre-virus level until the end of 2021.
There has recently been an uptick in new cases in many states where preventive measures were eased. If widespread stay-at-home orders return, the U.S. recovery would reverse course, and unemployment would remain elevated for longer. By extension, we could expect deeper scarring from a more permanent job losses, negative wealth impacts, and business insolvencies, even with renewed stimulus measures. Naturally, outcomes could deviate from these expectations depending on policy decisions and virus developments throughout that period.
Based on the Federal Reserve Bank of Philadelphia’s U.S. Coincident Index, the gauge of U.S. economic activity registers a May 2020 reading at the zero percentile from January 1979 to May 2020. Source: Capital Market Consultants, Inc.
Recent Developments: As difficult as the first quarter of 2020 was for investors, the second quarter proved to be nearly as spectacular in a positive direction. Despite the severity of the COVID-19 induced recession that began to grip the economy in Q1, in Q2 markets continued to respond to the extraordinary intervention measures of the Federal government. In the U.S., the strong positive result in market performance appears to be explained by investor expectations that the recession has bottomed, that continued monetary and fiscal support will be forthcoming as needed, and earnings will pick up.
Developed equity markets overseas generally lagged those in the U.S., and remained moderately priced relative to the U.S. Despite the inferior relative performance, returns for the quarter outside the U.S. were mid- to upper-teens. The national responses to the pandemic in developed countries in continental Europe and Japan were forceful, disciplined, and lengthy though the health crisis caused short term negative economic results there as well. Emerging market equities also posted a strong quarterly result though there were regional variances from South America to Asia.
Fixed income markets posted strong relative returns with interventions from Central Banks and their guidance that rates will remain low for the foreseeable future. Riskier segments of the fixed income market like high yield bonds and emerging market debt posted double-digit gains as nascent signs of recovery surfaced. Investment-grade corporate bonds returned over 8% buoyed by assurances from the Federal Reserve that they will support that market if needed.
Outlook: It is not unreasonable to expect the stock market to bounce around for an extended period until the economy finds firmer footing. Despite this expectation, the U.S. stock market appears to be priced for a quick economic recovery. The resulting stretched valuations will become a concern if something other than a quick economic recovery becomes reality. The longer-term outlook appears more positive, however, as the recent slowdown was not driven by economic imbalances.
In Europe, economies are recovering from the lockdown and, thus far, there has been little evidence of a significant second wave of infections. Current infection data suggests that the pandemic is under greater control in most of these countries than the U.S., and it would not be unreasonable to expect their economies to recovery more quickly than in the U.S. Should that happen, their markets and currencies are likely to respond in kind. The outlook in Japan is less attractive as the result of weak monetary policy and persistent deflation. The U.K. has been hit hard by the coronavirus crisis and faces uncertainty related to Brexit. All things considered, the inclusion of an appropriate allocation to developed non-US stocks in a diversified portfolio remains prudent.
Emerging markets, however, are a more diverse group, including in their abilities to respond to current challenges. In many emerging countries, the pandemic appears to have not yet peaked, and economic activity remains locked down. China, the largest emerging market, seems well-positioned for a strong rebound through the second half of 2020 and into 2021 as government stimulus kicks in and the global economy recovers. We think some exposure to emerging markets is appropriate, but coronavirus related risks suggest that caution is prudent.
For fixed-income investors, the environment remains relatively challenging with yields on 10-year Treasuries ending the quarter around 0.67%. In more “normal” circumstances, these yields would be unattractive, but developed market government bonds serve a useful role as portfolio ballast. In the credit markets, while there may be select opportunities for investment in attractively-priced securities within the high yield asset class, caution is appropriate as increased defaults are likely in the months ahead. High-quality fixed income should continue to play a useful role in managing overall portfolio risk. However, the prospect of an economic recovery, especially if accompanied by high government debt loads, tempers overall enthusiasm for fixed income investment total return prospects.
Based on the S&P 500 trailing twelve month Price-to-Earnings ratio, the gauge of U.S. equity valuation registers a current reading at the 10th percentile from January 1957 to July 2, 2020. Source: Capital Market Consultants, Inc.
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This economic and market commentary was prepared by Capital Market Consultants, Inc. (CMC), an independent investment management consulting firm, and has been approved for distribution by GW & Wade, LLC. Data used to prepare this report by CMC are derived from a variety of sources believed to be reliable including well established information and data software providers and governmental sources. CMC is not affiliated with any of these sources.
The equity valuation and economic activity gauges have been reviewed by GW & Wade and are consistent with the firm’s near-term outlook.
The information provided above is general in nature and is not intended to represent specific investment or professional advice. No client or prospective client should assume that the above information serves as the receipt of, or a substitute for, personalized individual advice from GW & Wade, LLC, which can only be provided through a formal advisory relationship.
About the indices presented above:
- Standard & Poor's 500 (S&P 500®) Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance.
- The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq.
- The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
- The MSCI ACWI (All Country World Index) is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world.
- The MSCI EAFE Index is an equity index which captures large and mid cap representation across Developed Markets countries around the world, excluding the US and Canada.
- The MSCI Emerging Markets Index (EM) captures large and mid cap representation across 24 Emerging Markets (EM) countries.
- The Bloomberg Barclays Global Aggregate Bond Index measures global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
- The Bloomberg Barclays US Aggregate Bond Index measures the performance of the U.S. investment grade bond market. The index invests in a wide spectrum of public, investment-grade, taxable, fixed income securities in the United States – including government, corporate, and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities, all with maturities of more than 1 year.
- The Bloomberg Barclays US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.
- The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
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