Quarterly Newsletter Q2 2020

Quarterly Newsletter Q2 2020

Posted By FAS Team

 

A Fed Fueled Recovery

We hope this finds you well and that everyone is staying healthy during these odd and unprecedented times.

If there were ever a time that illustrated the idea the market is a forward-looking mechanism, it would be the second quarter of 2020. All major market indices hit what would appear to be their bottoms on March 23 in late Q1. Investors and economists began to see COVID-19 cases peaking in mid-April, much in part due to the economic shutdowns across the U.S., and reacted accordingly. What ensued was a historic rebound driven by the anticipated reopening of the economy, prospective COVID-19 treatments and vaccines, and fiscal and monetary stimulus from governments and central banks around the world. The markets appear to have essentially chalked up 2020 as a loss and are focusing now on the economy bouncing back in 2021. With S&P earnings falling nearly 50% in Q1, that is the only justification for current market levels with regard to the lofty valuations at which we currently sit.

The S&P 500 rallied over 12% in April alone and finished the quarter up nearly 20%. The Dow returned 17.8% while the NASDAQ returned over 30% in Q2. The S&P and Dow are still down 4% and 9.55%, respectively, for the year. The NASDAQ, which turned positive in May, is up over 12% year-to-date thanks primarily to tech, healthcare and cyclicals which make up nearly 70% of the index and have been the best performing asset classes this year.

Small caps outperformed large caps with the Russell 2000 returning 25% in Q2 yet still lag the S&P by over 9% on the year, though that is slightly deceiving. Small caps tend to be much more sensitive to economic changes and are therefore much more volatile than large caps – i.e. they fall harder and come back stronger. Keep in mind the Russell 2000 was down over 30% in Q1 while the S&P was down 20%. A 20% draw-down requires a 25% increase to break even while a 30% draw-down requires a 43% increase to break even.

Fixed income remained relatively stable as rates on the intermediate part of the yield curve continued to fall. The Bloomberg Barclays US Bond Aggregate returned 2.87% in Q2 and remains up over 6% on the year. The initial spread widening in corporate bonds (i.e. the difference between corporate bond yields and treasury yields) was muted mid-quarter as the Fed first began buying corporate bond ETFs, then eventually individual corporate bonds, in order to keep rates low. When short-term borrowing rates are at zero it leaves nowhere else for the Fed to go to create stimulus and improve liquidity, which leads to measures such as these in order to keep prices stable and liquidity in check.

The rally beginning in early April continued in May as the spread of the corona-virus continued to slow, paving the way for economic reopening in the U.S. and abroad. By the end of May all 50 states had at least partially reopened their economies, leading to a stronger-than-expected economic recovery. Meanwhile, economic stimulus from both the Federal government via unemployment checks and PPP loans to businesses and the Federal Reserve via bond purchases provided ample support to the recovery.

The two-plus-month rally was interrupted in mid-June due to a sudden resurgence in COVID-19 cases. Numerous states including Florida, Texas, Arizona and California saw cases begin to increase mid-month, and by the last week of June new daily COVID-19 cases in the U.S. hit an all-time high. As a result, volatility edged higher into the end of the quarter, albeit at a drastically muted rate compared to February and March, as the increased case count had not yet put extreme stress on state healthcare systems.

As we transition into the second half of the year with much of the economic pain hopefully behind us, it is important we understand what to expect moving forward. The last several weeks have made it clear we are not out of the woods when it comes to the virus, and

Announcements

Please join us in welcoming our newest team member to FAS, Tim Wickey, who will serve as a wealth and investment manager. Tim received a BA in Computer Science from The University of Missouri and his JD from The University of Missouri Kansas City. He comes to FAS with more than 20 years of industry experience and we are excited to have him on board.

We also want to remind everyone of the latest IRS ruling with regard to the CARES Act. The decision ensures anyone who took a required minimum distribution (RMD) in 2020 is eligible to return it to their account by Aug 31 to avoid tax consequences. This decision corrects the effects of the previous ruling which excluded those who may have taken their RMDs earlier in the year. Please reach out to your advisor with any questions or to learn more about your options with regard to your RMD.

while the administration has made it abundantly clear they do not intend on shutting down the economy again, that does not mean the effects of a resurgence in cases will not have an impact on economic activity. Despite the quicker-than-expected recovery we have seen, the current levels of economic activity are still far lower than those of one year ago. The bottom line is that the road to recovery is not only long, but also not one single road. The world emerging from the pandemic will most likely look much different from the one we knew in January as behaviors, sentiment, and spending habits are being transformed. Things are still very unclear and that uncertainty indicates we can expect volatility levels to remain elevated.

Additionally, we would be remiss for not acknowledging the primary reason the markets and economy have bounced back so strongly – i.e. the $3T elephant in the room. The Fed has expanded its balance sheet from $4T in March to over $7T today and the federal deficit is expected to eclipse $3T by the end of the fiscal year in September. Regardless of the different schools of monetary theories we subscribe to, we can probably agree this trajectory is not sustainable without eventually undermining the value of the U.S. dollar. The good news, for now, is that the U.S. is not the only one running this experiment as all central banks are doing the same. Central bank policy is an imperative factor in portfolio construction and asset allocation since it is the Fed who ultimately sets interest rates. Given what we have seen in recent months, it would appear we are continuing down the path of “lower for longer” with regard to Fed policy.

Moving into the second half of the year the economy continues to show signs of improvement but still faces quite a few headwinds; primarily the fear of the unknown. However, history has shown a long term approach combined with a well-designed and well-executed investment strategy can overcome periods of heightened volatility, market corrections and bear markets. We have experienced that first hand so far in 2020. Your advisors at FAS are here to guide you through these unprecedented times and ensure you remain on track to reach the goals you have laid out in your plans.