Second Quarter 2020
The friendship between Martha Stewart and Snoop Dogg seems unlikely. She’s the polished lifestyle expert who gives new meaning to the concept of domestic perfection, and he’s a pot-smoking rapper. And yet, not only is their friendship very real, it led to two seasons of the Emmy-nominated show Martha and Snoop’s Potluck Dinner Party. Who could have predicted the success of these unlikely besties hosting a weekly potluck? Not many because frankly, it doesn’t make sense.
Neither did the second quarter which was a study in improbability and incongruousness. Even veteran investors scratched their heads as markets staged an incredible comeback from the brutal losses suffered in March – despite grim headlines and bleak forecasts. It was as if we were living in a pre-COVID world where the wheels of a healthy global economy turned steadily, and the idea of a near total global shutdown resulting from a pandemic was as absurd as the idea of Martha and Snoop’s weekly potluck.
Excluding the bond between Martha and Snoop, it’s human nature to want things to make sense. And there are several explanations for the disconnect between investor optimism which fueled a massive market rally - it was the best 3-month period in 20 years – and the reality of a staggering increase in the number of COVID-19 cases, depressing earnings reports, and ongoing uncertainty around what economic recovery looks like – and just how fast it will arrive.
1. Oftentimes economics is backwards looking – meaning economists are analyzing data and outcomes that have already happened. In contrast, markets are forward looking. Investors are buying and selling based on future expected cash flows. It didn’t matter if we were faced with bad news during the quarter – investors had already priced that into the markets during the sell-off in March, and now, they were trading with an eye towards future growth and brighter economic prospects. Perhaps the most perfect example of this contradiction came on June 8th when the National Economic Bureau of Research (NEBR) announced that the U.S. had officially entered a recession back in February. Now I don’t think this was really news – most everyone had known for several months that the economy wasn’t good even if we couldn’t rattle off the specific data points to back it up. But on June 8th we got the official word – and what did the U.S. market do? The S&P 500 rose 1.2% to push into positive territory for the year (after being down over 30%) and the NASDAQ closed at an all-time high. Go figure.
2. Many credit the aggressive actions by the Fed for the rapid recovery as Jay Powell and his team came swooping in on their stallions, brandishing aggressive monetary policies like swords and shouting: “The economy is not going down today! Not on our watch!” After slashing interest rates to near zero, the Fed’s primary strategy was Quantitative Easing (QE) i.e. buying bonds on the open market in order to inject money into the economy and encourage lending and investment. It was a strategy that worked well back in 2008 when the Fed spent $1.4 trillion over ~ 2 years in order to keep the U.S. economy from sinking into a Depression. But the Global Financial Crisis has nothing on COVID-19. So far, the Fed spent $2.9 trillion in just 3 months on a bond buying spree that seems to know no bounds. In addition to the usual (and safe) Treasuries and government-backed securities that the Fed usually buys, they have expanded their investment universe to include corporate bonds, munis, and even junk bonds! They have even taken to buying bonds on the secondary market. The scope and scale of their efforts is unprecedented, and Jay Powell has said the Fed will do whatever it takes to stabilize our economy.
3. Another factor driving the market’s upward momentum during the second quarter – at least early on – was the steady rise of Megacaps including Amazon, Apple, Facebook, Google and Microsoft. Imagine a winning basketball team where the 5 starters are so incredible that they play the entire game – nay the entire season – by themselves, while the other players sit on the bench. That’s the best analogy for what happened early in the quarter as the huge gains posted by a handful of companies drove the S&P 500 higher, while masking the overall dismal nature of what was happening with most of the other ~ 495 names in the index.
4. According to some analysts, yet another possible explanation for the market’s quick and steady climb was the emergence of the gambler-turned-day trader. With sporting events – and therefore sports gambling – on hold, many saw the markets as a substitute for casinos and started to place their bets. David Portnoy took this phenomenon to a whole new level by live streaming his day trading to an audience of 1.5 million followers on social media while boasting that he was better than Warren Buffet which led to this Bloomberg headline: “Barstool Sports Dave Portnoy is leading an Army of Day Traders.” While you can’t discount the idea that millions of first-time investors had an impact on the markets, the extent of their impact - especially compared to large institutional investors and other market makers - is unknown. And I would argue that at least in Mr. Portnoy’s case – he was less of an investor and more like a shark circling the chum of deeply discounted – and in some cases bankrupt – companies like Hertz and J.C. Penney. Latecomers to some of these distressed names were disappointed, as speculative advances gave way to market prices reflecting the very real challenges these companies now faced.
As much as we might feel driven to attempt an explanation of what happened and more importantly why it happened – the fact of the matter is – we don’t have to. There’s a reason why we take an academically based, empirically proven approach to investing and that’s because markets are out of our control. Sometimes markets make sense and sometimes they don’t. Sometimes markets move in lockstep with headlines, and sometimes, they don’t. Sometimes they can be as frustrating as a teenager breaking curfew, and sometimes they are like your favorite child who eats all their veggies without having to be told twice.
Trying to make sense of the market in order to outsmart it is a fool’s game – and one that is not won in the long run. Frankly – we don’t consider that to be investing. It’s speculating.
We believe that you, our clients, are better served by what we have learned from decades of financial research and science. That knowledge guides our investment philosophy and drives the decisions we make on your behalf including:
(i) Which asset classes to invest in given their risk/reward parameters
(ii) Which funds to purchase to capture each asset class in your portfolio
(iii) The right weighting of each asset class to reflect a given risk profile
Our disciplined approach to investing helps ensure that you have a successful investment experience – regardless of what the market is doing. And by focusing on the things we can control – and not worrying about the things we can’t – we stay true to our mission of enriching clients’ lives by delivering financial clarity and peace of mind.
Second Quarter Asset Class Returns - Bill Laird, CFA, CFP®, Co-Chief Investment Officer
The bond market continued to dominate headlines in the second quarter, driven in large part by the extraordinary actions of the Fed. As we wrote last quarter, bond prices and yields are inversely related – so when prices go up – which they will do when there is increased demand – yields go down. One result of these massive QE measures are very low yields on Treasury Bonds, providing a significant benefit to borrowers, but not much in return for aficionados of these traditional safe havens. Yields on bonds carrying higher risk like corporate and municipal bonds have fallen from March’s stressed levels but are higher than those seen prior to this most recent bout of volatility. The Fed’s direct actions and stated willingness to intervene further have served to calm the bond market, which serves as the primary “bank” for the government and public companies. This has provided a signal to investors that capital markets are stable, allowing for significant price improvement in both stock and bond markets from very stressed levels.
On the stock side, the outperformance of the Megacaps was not the full story. Towards the end of April markets shifted with advances becoming broader. Value stocks and small capitalization stocks saw significant advances in line with a belief in the possibility of the economy opening more broadly, and Small Caps actually outperformed Large Caps for the quarter both domestically and abroad. Overseas markets also advanced nicely based on the same narrative and an easing of the advance of the dollar, which served as a safe haven during the early year’s market stress. Market advances were broad for the quarter with the All Country World Index returning over 16%.
The Bears believe that the gains we saw last quarter are a blip, and that we can expect another correction soon. The Bulls say that the losses we suffered back in March were the outlier – and that the future is all sunshine and roses. We’re not in the crystal ball gazing business so we can’t say what comes next. What we do know is that with the pandemic not yet under control, uncertainty around the timing and nature of an economic recovery AND a presidential election, markets will have a lot of information to digest during the second half of 2020.
As we wait to see what happens, we welcome the start of summer, the return of Major League Baseball, and being able to stream Hamilton (with the original cast!) in our homes.
Stay safe. Stay healthy. Take care.
DHG Wealth Advisors
The content in this newsletter is for informational purposes only and does not constitute investment advice or an offer to buy or sell any security. The information in this newsletter is believed to be accurate as of the time it is distributed and may become inaccurate or outdated with the passage of time. You should contact your financial advisor or CPA professional before making any tax or investment-related decision. Past performance does not guarantee future results. All investments may lose money.