Economic Flash: More Room Left to Run?


July 2020

US Economy: Reopening rebound.

Economic data leaned positive in June with surprise increases in manufacturing activity and durable goods orders while unemployment fell to 11% (from 13%). Existing home sales fell for the 3rd consecutive month but pending sales spiked over 40% suggesting a real estate bottom and a continued rebound in consumer spending.

US Stocks: Best quarter since 1998.

US equities pushed higher early in the month before fears of a Covid-19 second wave dampened enthusiasm. The S&P 500 notched a quarterly return of more than 20% for the first time since 1998. Performance continued to be led by growth sectors, as tech and consumer discretionary rose 7.0% and 5.8% respectively.

Foreign Stocks: EM surprise with rally.

Non-US stocks also gained, with emerging markets (EM) outpacing their developed peers, despite rising Covid-19 infections in Brazil and India and re-ignited trade conflicts between China and the US. A falling US dollar and central bank stimulus were contributing tailwinds to EM equities.

Fixed Income: TIPS yield below zero.

While credit markets continue to repair, inflation-protected Treasuries – aka TIPS — were the strongest fixed-income category on investor concern that the huge increase in government spending would eventually re-ignite inflation. The current yield on 5-year TIPS is a negative 0.9%, suggesting US inflation of only 1.2%.

Real Assets: Gold keeps rising.

Gold rose roughly 3%, finishing June near $1,800. Alternative stores of value such as gold and bitcoin (-3.8% in June) are likely to see increasing interest from investors as the path forward for the global economy remains highly uncertain and monetary policy puts downward pressure on the US dollar and other major currencies.

Alternatives: Modest gains continue.

Hedge funds posted solid monthly returns in aggregate, with most broad-based approaches in positive territory and event-driven strategies (+2.6%) the strongest performers. Performance was disparate across managers however, highlighting the importance of a well-constructed and diversified approach to the asset class.

Equities Total Return

U.S. Large Cap 2.0% (3.1%) 7.5%
U.S. Small Cap 3.5% (13.0%) (6.7%)
U.S. Growth 4.3% 9.0% 21.9%
U.S. Value (0.5%) (16.8%) (9.4%)
Int’l Developed 3.4% (11.3%) (5.1%)
Emerging Markets 7.4% (9.8%) (3.4%)

Fixed Income Total Return

U.S. Agg. Bond 0.6% 6.1% 8.7%
TIPS 1.1% 6.0% 8.3%
U.S. High Yield 1.0% (4.8%) (1.1%)
Int’l Developed 0.6% 1.1% 0.7%
Emerging Markets 0.8% (0.7%) 2.1%
Intermediate Munis 0.5% 2.1% 3.7%
Munis Broad Mkt 1.0% 2.0% 4.3%

Non-Traditional Assets Total Return

Commodities 2.3% (19.4%) (17.4%)
REITs 2.3% (13.3%) (6.5%)
Infrastructure (1.2%) (19.4%) (14.8%)
Hedge Funds
Absolute Return 1.5% (1.2%) 1.4%
Overall HF Market 1.6% (1.2%) 3.0%
Managed Futures (1.2%) (2.5%) (1.1%)

Economic Indicators

JUN-20 DEC-19 JUN-19
Equity Volatility 30.4 13.8 15.1
Implied Inflation 1.4% 1.8% 1.7%
Gold Spot $/OZ $1781 $1517 $1410
Oil ($/BBL) $41 $66 $67
U.S. Dollar Index 120.9 116.0 115.4

Glossary of Indices

Our Take

We’ve been skeptical of the stock market rebound, given that investors have not fully come to terms with the scope of the COVID-driven economic downturn. While the financial markets capped off a very strong second quarter as economies reopened and economic data improved, it is fair to acknowledge that we cannot call Covid-19 contained or predict with any conviction when that will happen. In fact, rising Covid-19 infection rates in many US states suggest a turn for the worse, indicating what we have anticipated at LNWM: a protracted period of living with the virus and a slower recovery as a result. That US equities and other risk assets cooled off a bit in the second half of June indicates that perhaps more investors are tempering their expectations.

Near Term vs Long Term

Are there reasons to think markets might hold up just fine this year? Yes. Certainly, Congress and the Fed have spent heavily to support businesses, local governments and consumers. So far in 2020, US government commitment to the crisis has been more than 20 times greater than during the 2008 crisis. Provided this support remains ongoing, as will likely be necessary, it will continue to be a powerful force in buoying equity markets. Additionally, many businesses are adapting to the new normal, jobs are returning and our understanding of Covid-19 treatment improves each day.

However, we aren’t yet ready to dial-up risk substantially in client portfolios. We do think there are likely scenarios that portfolios should be prepared for and select opportunities within equities. For example, in the long term, we think the cost of an avalanche in government spending is likely to be inflation, higher interest rates and a weaker US dollar. Inflation protection via real assets and other inflation correlated investments looks prudent given this backdrop. Within equities, small-cap stocks in emerging markets offer above-average growth, have been disproportionately beaten up and could be get a boost from dollar weakness.