Following a less-than-rosy start to the year, the second quarter of 2020 was marked by a strong rebound across financial markets. While the ongoing coronavirus pandemic, or COVID-19, was still present, certain parts of the country experienced a steady decline in positive case counts and began the early stages of their re-opening phases. This, along with society adjusting to the new normal under quarantine more generally, has led to the start of a reversal in the unemployment rate and a rise in U.S. retail sales. Domestic equities responded positively to this news, with the S&P 500 Index gaining 20.54% during the quarter – the best quarterly return on record since 1998.
Internationally, the rebound seen in domestic equities also played out in both developed and emerging market economies. While international developed economies tended to be structurally more adept at dealing with the spread of COVID-19 than their emerging peers, developing equity markets proved comparatively durable. In fact, the MSCI Emerging Market Index saw its best quarter in over a decade, returning 18.14% and outpacing the developed market composite’s 15.15% gain.
The fixed income space continued to be guided by the Federal Reserve’s accommodative policy measures and investor’s desire for safe havens in a tumultuous equity market. With the Fed’s discount rate now sitting at zero percent, Treasury yields remained at historically low levels, with the U.S. 10 Year Treasury Note ending the quarter yielding a measly 0.66%. Additionally, while the Fed signaled an unwillingness to push rates into negative territory, further monetary policies aimed at lessening the economic impact of COVID-19 were instituted to include the purchase of corporate bonds. As a result, both investment-grade and high-yield corporate bonds rallied through quarter end, outpacing municipal issues, which have lagged in part due to uncertainties over municipal revenue sources.
Outlook: Given that the stock market bottomed just one week prior to the first quarter’s end on March 23rd, the second quarter is almost a perfect snapshot of the market recovery since that point. While this means that statistics like “the best quarter since 1998” are coming off of a notably low base, it is also an opportune reminder that short-term market volatility is inherently unpredictable and transitory. Making wholesale changes to a portfolio during these especially volatile times almost never pays off, as it causes you to both lock in losses and miss out on at least a portion of the recovery.
Still, with the world still largely on lockdown and the economy far from back to where it was six months ago, it is fair to ask what has driven such a robust comeback. As we noted last quarter, markets are forward looking, so the facts on the ground at this moment are not nearly as important as market participants’ expectations for what the future holds. And the facts on the ground have improved in many ways. States are doing a better job of pinpointing high-risk areas and activities, hospitals and healthcare systems are no longer as overrun as they once were, and despite the lack of a knowable timeline, the private sector and various health organizations are coordinating well in their efforts to formulate a vaccine. Firms like Johnson & Johnson, Novavax, and Pfizer all have potential vaccines in Phase One clinical trials, while Moderna and AstraZeneca have prototypes entering Phase Two.
While the inherent trade-off between virus containment efforts and reduced economic growth will continue, there are early indications that certain sectors of the economy are on the rebound as well. To be sure, air traffic and seated diner data have yet to show significant improvements, and many small businesses and displaced employees are still out of work, but many trends are back to moving in the right direction. Mortgage applications, driving direction usage, and room occupancy rates in drive-to leisure markets have all strengthened notably over the past six to eight weeks. The unemployment rate, while still high, has fallen by over 3.5% since its high in April. And though GDP will decline significantly in 2020, estimates for 2021 have risen by over 15% since February as forecasters predict that delayed activity will come surging back following the inevitable reopening.
Finally, one factor that cannot be underestimated in this recovery is the unprecedented economic stimulus being provided by the Federal Reserve and federal government. The Fed’s balance sheet, which had grown past $4 trillion this decade, is now forecast to approach $8 trillion by year-end. In addition to the money being pumped into the economy, the central bank is also lowering reserve requirements, establishing emergency lending facilities, and promoting liquidity in currency and credit markets more generally. Meanwhile, on the fiscal side, Congress has passed the CARES Act and numerous other pieces of legislation intended to provide economic relief with bipartisan support. Whereas monetary policies have stepped in to support financial markets, programs like the Paycheck Protection Program have simultaneously been put in place to come to the aid of small business. We expect support for these stimulative fiscal policies to continue.
With the pandemic ongoing, reopening efforts exhibiting mixed results, and an uncertain and divisive presidential election coming down the line, it would be premature to assume that we have seen the last of short-term volatility. Yet if the events of the second quarter teach us anything, it is that sentiments can improve and markets can rebound almost as quickly as they fall. As always, we will continue to monitor markets closely and work our hardest to ensure your portfolios are positioned appropriately for your long-term goals and objectives.
