With a full quarter of dealing with the coronavirus at our backs, our path to recovery remains shrouded in ambiguity. While there were many approaches to the shutdown, there appears to be just as many in reopening. Talk of a vaccine has been abundant, but as of now it remains just that, talk. Absent a known medical approach to safeguarding all, the economy continues to be shut down to various degrees to protect the most vulnerable members of our population.
While there was much diversity regarding the opinions of the virus, it’s severity, and what our response should be, there is an equal diversity of opinions about the economic impact of the virus. While the economic foundation that led the U.S. economy to a record long expansion remains in place, recent events, especially recent political and domestic unrest, could make a quick recovery even more difficult.
Perhaps the most readily apparent indication of the economic impact the shutdown has had is employment. Weekly unemployment claims spiked following the first wave of economic shutdowns but has rebounded since. On the heels of the dramatic, yet expected, decline in April of over 20 million jobs, May Nonfarm payrolls surprisingly expanded by over 2.5 million employees versus an expected decline of 8 million. Undoubtedly the economic stimulus package including the Paycheck Protection Program has helped smoothed some of the pain.
Preliminary indications are that first quarter GDP contracted at a 5.0% rate. This starkly contrasts with the pre-virus expectations of roughly 1.5% growth. Looking forward, the pain is expected to have really been felt this quarter as consensus forecasts for second quarter GDP indicate a 32% contraction. How deeply the economic strain these shut-downs have caused will be largely dependent upon how quickly the economy reopens and snaps back from the stress of closure.
Other economic areas have seen similar decline and volatility. Following a sharp decline of 4.5% in April, consumer prices stabilized in May, declining by 0.1%. Going forward, inflation is expected to remain benign. Consumer Confidence rebounded to 98.1 versus an expected reading of 90.1 and prior 85.9, though still far below the pre-virus number of 132.6. These levels of low consumer confidence have not been seen since 2015.
One area of the economy that has surprisingly remained firm is new home sales, which have remained robust. If looking for that half-full glass, recent comments from Fed Chairman Powell could provide hope. He has noted that incoming data is beginning to reflect a resumption of economic activity. Specifically noting a pickup in hiring, increased business spending and investment, a recovery in employment, and a strong rebound in consumer spending. However, he also noted new potential challenges from the need to keep coronavirus in check.
With November’s elections nearing and a broad dispersion of ideologies to choose from, eyes will be firmly focused on possible outcomes and their effect on both the U.S. and world economies.
After falling dramatically near the end of the first quarter as a result of both Federal Reserve easing policies and an investor flight to safety, interest rates remained very low throughout the second quarter. Although subtle, any rate movement has generally been toward lower rates on shorter maturities and higher on longer bonds. This slight steepening of the yield curve, and the slight rise in T-bill rates, may be signaling that the fixed income market is beginning to price in economic recovery and higher future rates.
With the Fed Funds rate at or near zero, and a reluctance to enter the negative rate environment that has proved dreadful in other developed markets, the Fed can be expected to leave the Fed Funds rate alone for some time. However, the Fed has been far from quiet this quarter, continuing to buy debt, especially corporate debt, in the open market to boost both liquidity and investor confidence in the bond market. Unwinding of these purchases must be done carefully, as reducing these holdings and therefore reducing liquidity too rapidly can potentially stifle economic growth.
Bond market investors have mirrored the optimism of equity markets as they have methodically divested safer holdings, such as Treasuries, and increased portfolio risk, seeking total return. After hitting lows around mid-quarter, yields on Treasuries rose steadily through early June, then declined to current levels. Yields on 2-year Treasury Notes traded between 0.13% and 0.28% while ten-year Notes saw a range of 0.58% to 0.91%.
As a result of the move to riskier assets, the value of corporate debt has recovered sharply. The second quarter saw corporate spreads, or the additional yield received for buying corporate bonds instead of Treasuries, decrease significantly to almost half of their high levels near the end of March. This decline in rates on corporate bonds have led to their significant relative outperformance of other bond sectors in the second quarter (as bond prices move in the opposite direction of interest rates).
Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|2nd Quarter 2020 Returns|
Barclays Capital US Aggregate
|2.90%||BofAML US High Yield||9.61%|
|BofAML US Treasuries||0.20%||BofAML Municipals AAA||2.92%|
|BofAML US Corporate||9.27%||BofAML US Mtge Backed Security||0.81%|
|12-Month Returns (as of 6/30/20)|
|Barclays Capital US Aggregate||8.74%||BofAML US High Yield||-1.10%|
|BofAML US Treasuries||10.76%||BofAML Municipals AAA||5.51%|
|BofAML US Corporate||9.30%||BofAML US Mtge Backed Security||5.80%|
Despite the slowing effect of the lockdown and the accompanied economic uncertainty, stock indices rebounded nicely during the second quarter. For the period, the S&P 500 rallied by nearly 21%, posting its biggest quarterly gain since Q4 of 1998. This rebound followed the 19.6% selloff in the first quarter.
Providing the most significant boost for stocks has been the massive monetary and fiscal stimulus packages which were implemented in late March. Additional boosts to the market have been the talk about reopening the economy, the accompanying bottoming of global economic activity, corporate commentary indicating a potential improvement in demand, and optimism about the potential for coronavirus vaccines and treatments. Together, they have led to a more optimistic expectation of a V-shaped recovery along with a rebound of corporate earnings.
Given all that has gone on and all that has changed in the equity market with recent events some things, however, have remained the same. For several quarters prior to the shutdown technology and growth stocks drove much of the index returns. This dichotomy of returns, where technology stocks drive performance and where growth stocks are favored over value stocks has continued in the second quarter.
Given this, it is no surprise to see the NASDAQ Index leading market performance again this quarter. This index is dominated by large growth stocks, in fact the largest 3 companies comprise over 28% of this index and the top 10 companies are nearly 45%. The growth versus value bias can clearly be seen, as the S&P 500 Growth Index clearly outpaced the S&P 500 Value Index, 26% to 13%. Small Cap stocks, as best represented by the Russell 2000 also performed well the period, posting a return of over 25%.
Below is a table which displays various equity index returns for the past quarter (data from Bloomberg).
|Equity Indices||2nd Quarter 2020|
|Dow Jones Industrial||18.51%|
|S&P 500 Growth||26.23%|
|S&P 500 Value||13.15%|
|Russell 2000 (small-cap)||25.42%|
|MSCI/EAFE (developed international)||15.15%|
|MSCI/EM (emerging markets)||18.14%|
Joining the consistent market favorite and performance leading Technology sector this quarter are the Consumer Discretionary, Energy, and Materials sectors. The Information Technology and Consumer Discretionary sectors have recovered enough to post positive YTD returns, at around 15% and 7%, respectively. However, all other sectors are still negative for the year, especially energy, which is still down over 35% so far in 2020.
Consumer staples and utilities, sectors which performed well during the first quarter, as investors sought out stocks perceived to offer safe and reliable dividends, significantly lagged sector performance this quarter.
The following table details S&P 500 sector total returns for the quarter (data from Bloomberg).
|Return by Stock Sector||2nd Quarter 2020|
|1. Consumer Discretionary||32.86%|
|2. Information Technology||30.53%|
|5. Communication Services||20.04%|
|7. Health Care||13.59%|
|8. Real Estate||13.21%|
|10. Consumer Staples||8.12%|
The Investment Overview is published quarterly by the Union Investment Management Group of Union Bank & Trust Company. Please address correspondence to: Union Bank & Trust, Attn: UIMG, PO Box 82535, Lincoln, NE 68501-2535.