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:
“Nothing in life is to be feared, it is only to be understood. Now is the time to understand more, so that we may fear less.” ‒ Marie Curie
The Fed continues to multi-task
Last week’s Federal Reserve meeting capped an historic three-month stretch beginning with March’s trio of emergency meetings to bolster the U.S. economy against COVID-19. This time, there were no “shock and awe” policy announcements.
The Fed kept its fed funds target rate at zero (0.00% - 0.25%) while also offering dovish, albeit unconventional, forward guidance. For example, at his post-meeting press conference, Chair Jerome Powell stated that “We’re not thinking about thinking about raising rates.” Indeed, the Fed’s latest “dot plot” of interest-rate forecasts shows that members of its board of governors unanimously expect rates to remain at zero through 2021, with a vast majority anticipating this “lower-for-longer” stance to persist through 2022.
What Powell and his colleagues are thinking about is buying more bonds. Last week they pledged to maintain “at least” their current pace of quantitative easing (QE) asset purchases, about $80 billion/month of U.S. Treasuries and $40 billion/month of agency mortgage-backed securities.8 The Fed kicked off a fresh round of QE in March—the first since its “QE3” program ended in 2013. As a result, its balance sheet has ballooned by roughly $3 trillion, to $7.2 trillion, as of June 10, with the lion’s share of those purchases occurring during the program’s first two months.9
Especially loose monetary conditions are necessary, in the Fed’s view, given a cloudy forecast for the U.S. economy. The Fed expects U.S. GDP growth to shrink by 6.5% this year before expanding by 5% and 3.5% in 2021 and 2022, respectively. It also sees inflation remaining below its 2% target through 2022, and the unemployment rate falling yet staying elevated (6.5%) at the end of 2021.10
With its interest-rate policy on hold for the time being and QE set to continue, the Fed will focus more closely on getting people back to work. Even after the economy added 2.5 million payrolls in May, nearly 20 million Americans remain unemployed.11 Last Monday, June 8, the Fed expanded its Main Street Lending Program (MSLP) so more small and medium-sized businesses—key cogs in the economy—can receive badly needed financial support.
Under the terms of the revamped MSLP, the Fed:
- lowered the minimum loan amount (to $250,000 from $500,000)
- raised the maximum loan limit and
- extended the repayment period for all loans by delaying principal repayments for two years rather than one
Also on tap for the Fed: making loans to municipal bond issuers—states, localities and other public agencies—to help them meet financial obligations, including payrolls. More than 1.5 million government employees were laid off in April and May.12
U.S. recession, we hardly knew ye
According to the National Bureau of Economic Research (NBER), the official arbiter of U.S. booms and busts, the economy slid into recession in February, ending the longest expansion (128 months) in U.S. history.13 (NBER defines recession as “a significant decline in economic activity spread across the economy, normally visible in production, employment, and other indicators.”)
NBER also noted that this decline, despite its severity, could be “briefer than earlier contractions.” How brief? Perhaps just two months, considering signs of a May rebound that included improving manufacturing and service-sector activity and the addition of 2.5 million jobs.14 Moreover, high-frequency metrics—including traffic congestion, airline bookings and restaurant reservations—have been on a slow, steady upswing over the past few weeks. These measures provide a more “real-time” picture of the U.S. economy’s health.
But even if the economy continues to strengthen, we think a rapid, sustained, “V-shaped” recovery is unlikely. Why?
- While many businesses have already made the transition from being closed to operating at quarter- to half-capacity, ongoing uncertainty about the scale and scope of COVID-19 means that firms might need several months—or more—to reach pre-pandemic levels of revenue.
- In fact, some industries, especially those in the service sector, could take years to fully return to their prior capacity. The CEO of Delta Airlines, for example, is preparing for a “choppy, sluggish recovery” of two to three years “even after the virus is contained.”
- The personal savings rate has soared recently, and continued high unemployment could fuel more frugality. To the extent individuals decide to save rather than spend, the economy could see a smaller-than-desired boost from consumers.
- The economy might experience further shocks, most notably from a resurgence in the coronavirus itself (in states that previously had relatively few cases and/or those now beginning to experience a second wave) or in a more virulent form than it took this spring.
After the S&P 500 fell 5.9% last Thursday amid an uptick in coronavirus cases and the Fed’s downbeat forecast, investors may be wondering if stocks are headed for similar selloffs if the economy doesn’t quickly bounce back.15 Not necessarily, in our view.
First, with many investors waiting on the sidelines, there’s plenty of “dry powder” (available cash) that can still be deployed. According to Crane Data, money market assets have soared by 32% ($1.2 trillion) for the year to date through May 27.16 Even modestly better-than-anticipated economic data could coax investors to dip their toes in the equity pool.
And they might do so even though stocks aren’t cheap based on commonly used valuation measures like their price-to-earnings (P/E) ratio. Equities do look attractively priced, however, when compared to many traditional fixed-income asset classes, such as U.S. Treasuries and investment-grade corporate bonds.
Investor demand for these securities has driven their prices up and their yields down. Investment grade corporates, for example, yielded 2.3% as of June 12, down from 4.6% on March 20 at the peak of the COVID market turmoil.17 And the yield on the bellwether 10-year Treasury note has generally been trading in a tight range of 0.60%-0.90% after collapsing to its record low of 0.54% on March 9.18
Finally, two of the S&P 500’s largest sectors by market capitalization—information technology (23% of the index as of March 31, 2020) and health care (15%)—could outperform in the near-to-medium term.19 Tech companies, particularly software firms and chipmakers, have capitalized on shifting consumption trends during the pandemic. Meanwhile, health care stocks might benefit as people are able to make in-person doctor’s appointments again and hospitals begin admitting patients for highly profitable elective surgeries. Rallies in these sectors would provide solid support for the broad U.S. stock market.