The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s Q2 Update:
- U.S. economy: Looking for a relatively rapid recovery in the second half of 2020.
- Global economy: Europe may begin to outperform the U.S. in Q3.
- Policy watch: Fed to guide the economy even after the country reopens.
- Fixed income: Stay defensive, stay diversified.
- Equities: Focus on quality companies at reasonable valuations.
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“So long as the memory of certain beloved friends lives in my heart, I shall say that life is good.” – Helen Keller
The Fed has America’s back. Will it be enough?
When economic conditions were favorable just a few months ago, markets mused when, whether and by how much the Fed should raise interest rates. (Ah, the good old days!) After all, there was no need to consider rate cuts or other tools the Fed has at its disposal to stimulate the economy during times of stress, such as the 2008-09 global financial crisis.
But those tools and more have been on full display since the COVID-19 pandemic sent financial markets into a tailspin in March. In rapid response, the Fed has:
- Cut interest rates to zero and unleashed open-ended quantitative easing (QE) of U.S. Treasuries and mortgage-backed securities.
- Expanded its QE menu to include investment-grade corporate bonds, which it began purchasing (through exchange-traded funds) two weeks ago.
- Revived several financial crisis-era programs, including the Commercial Paper Funding Facility, the Primary Dealer Credit Facility and Money Market Mutual Fund Liquidity Facility.
In addition to keeping markets well lubricated through these monetary policy measures, the Fed will offer assistance, albeit indirectly, to nonfinancial businesses. Such aid normally originates not with the Fed but under the purview of fiscal policy legislated by Congress. (Then again, we’re not in the midst of a normal downturn.) Examples of this support include the Paycheck Protection Program (PPP) Liquidity Facility, which will buy bank loans made through the PPP established by the CARES Act to help small businesses keep workers on the payroll. And the Fed’s Main Street Lending Program will purchase loans made by banks to midsize companies with fewer than 15,000 employees or under $5 billion in annual revenue.
Considering the Fed’s aggressive policy initiatives, and with its balance sheet topping $7 trillion thanks to ongoing QE purchases, do Chair Jerome Powell and his colleagues still have firepower in their arsenal if they believe the economy needs further boosting?6 Powell believes so. “We’re not out of ammunition by a long shot,” Powell said in a recent interview. “There’s a lot more we can do.”
Powell also believes that Congress needs to amp up fiscal stimulus, and soon, by taking advantage of the U.S. Treasury’s ability to borrow at ultra-low rates. Without more government spending, he believes, “there could be longer-run damage to the productive capacity of the economy and to people’s lives.” The larger fiscal deficits that would be created by such spending are not on his list of top concerns. “Deficits are going to be big for a couple of years,” he acknowledged. “The time to deal with that is when we’re through this recovery.”
Powell’s recommendations, for now, are going unheeded. On May 8, in the immediate wake of April’s disastrous jobs report, President Trump stated that he was “in no rush” to negotiate another stimulus package—perhaps because doing so could appear to overstate the degree of economic damage, thereby harming his reelection chances. Not to be deterred, one week later, the Democratic-led House passed a $3 trillion relief package. But Republicans, who control the Senate, have indicated a preference for judging the impact of the $3 trillion CARES Act passed on March 27 before taking further steps.
And what might those steps entail? We expect more direct stimulus checks to individuals, some modified extension of unemployment benefits and additional funding for the Paycheck Protection Program.
Is a vaccine the key to a value rally?
After stumbling the week before amid dire economic data, warnings from Fed Chair Powell about COVID-19’s potential to harm the U.S. economy and heightened U.S.-China tensions, U.S. equities enjoyed a banner week heading into the Memorial Day holiday. The S&P 500 Index advanced 3.2%, due in part to optimism over the easing of lockdowns in the U.S. Some two months after the coronavirus forced the closure of the U.S. economy, all 50 states have now taken steps to reopen, albeit to varying degrees.
Driving last week’s rally were hopes for a potential COVID-19 vaccine. On Monday, May 18, biotechnology company Moderna reported promising results from a Phase 1 trial, propelling the S&P 500 Index to its best day (+3.2%) since early April.7 This broad advance wasn’t surprising, since markets view a vaccine or cure as essential to jumpstarting and maintaining an economic recovery. What did grab our attention was that value stocks outperformed growth shares, 4.8% to 2.4%.8 Value indexes have consistently lagged in 2020, trailing their growth counterparts in 17 out of the last 20 weeks.9
Could last Monday mark the beginning of a value comeback? Probably not yet, in our view.
Growth shares have benefited from hefty investor demand for companies with the potential to deliver strong earnings despite the financial and economic challenges posed by the coronavirus. This focus has helped the technology (+5.8% in 2020) and health care (-1.8%) sectors, two of the S&P 500’s better performers.10 But when credible headlines of a vaccine emerge, as they did last Monday, investors begin to feel more confident about the broad economic outlook. The result? They lean toward value stocks, which tend to be more economically sensitive and trade at lower price-to-earnings and price-to-book ratios than growth shares.
The challenge for value proponents, as we see it, is that rallies driven by encouraging public health headlines—such as progress toward a vaccine—have been relatively rare this year, and we don’t anticipate many more in the near term. Against that backdrop, investors hoping for a faster, stronger economic recovery that could help value stocks outperform over the balance of 2020 may have to extend their time horizons just a bit.