Slowly Emerging from the Storm
As businesses gradually begin to reopen, the upturn in the global economy has commenced. Trillions of dollars in federal spending and aggressive monetary easing provided the support mechanism needed to move us past the darkest hours of the Covid-induced economic decline. Meanwhile, scientific progress on vaccines is also rapidly progressing. The net result of these activities is that investors are looking ahead to a healthier and more normal economic environment, thus becoming more comfortable with holding stocks best positioned for the post-Covid era. Consequently, the S&P 500 is up 36% at the end of May from the recent low in late March, down only 6% for the year, and up 9% from a year ago.
The Federal Reserve is the one to thank for reversing the slide in the stock market. In times of great uncertainty, the majority of financial assets are besieged with sellers amid a scarcity of buyers, causing prices to drop rapidly and often inexplicably. This occurred simultaneously in both the credit and equity markets earlier this year as the pandemic set in. Then, in mid-March, the Fed cut short-term interest rates to zero. The following week, they promised to buy large amounts of corporate debt. On that news alone, buyers rushed back into the bond market. Large institutions and funds that needed to rebalance their portfolios–as the value of their stocks relative to bonds had plummeted–finally found the required liquidity to sell bonds and move that money into equities. Following weeks of rapid decline, stocks established a bottom despite the cloudy economic outlook.
The trillions of dollars pumped into the economy and financial markets via fiscal and monetary policy created a swollen money supply with large cash balances waiting to be put to work. Fed data shows that liquid assets (primarily money market mutual funds) rose to a record $16.4 trillion in May, up $2.6 trillion since the end of February. Much of that enormous sum of money will eventually find its way into longer-horizon investments, such as the stock market, as trillions of investing dollars have temporarily moved to the sidelines.
Currently, some of the most pertinent news from an economic perspective continues to be of the medical variety. Collectively, we have done an admirable job of flattening the virus curve, but the ultimate solution to the pandemic likely requires an effective vaccine. Utilizing many different approaches, there are now at least 10 vaccines in clinical trials and 114 in preclinical evaluation. A number of factors (effectiveness, safety, longevity, need, ability to manufacture, etc.) dictate how quickly any of these will make it to market and progress is rapidly being made in that direction. Something could already be available by early next year.
Successful curve flattening has enabled a reopening of the economy as Covid-19 cases continue to moderate globally. The labor market report for May showed that the economy is picking up earlier and faster than anticipated from the coronavirus-inflicted recession. Payrolls turned the corner and rose by 2.5 million, trouncing forecasts for a sharp decline following a 20.7 million tumble the prior month. The jobless rate was expected to jump to 19%, but instead fell to 13.3% from 14.7% in April. Canada also reported similarly positive data.
The stocks that we favor have been among the best as a group pre-Covid, during the market meltdown and also during the recovery. Growth stocks, particularly the larger ones, have had standout performance. These are companies with stable earnings, strong balance sheets and the ability to continue to grow revenues, earnings and cash flows. They had strong operating momentum heading into the pandemic and are proving their resiliency under the most stressful of conditions. Consequently, their stock prices didn’t suffer as much in the selloff and are again leading the market higher. We remain very bullish on their long-term prospects.
While it is likely that we may have seen the near-term bottom for stocks, risks still remain. The foremost concern is a potential second wave of infections now that restrictions are being relaxed. That event has the possibility of reversing much of the economic resurgence that we are beginning to see now. Additional negative catalysts that may impact the market range from civil unrest to U.S.-China tensions and the upcoming elections.
With the stock market’s large bounce off the bottom and the fragility of the economic reopening, the market may be due for a pause. In these tumultuous times, many investors have been extremely cautious and underallocated equities. The large existing cash balances combined with additional as-needed fiscal and monetary stimulus should make any pullback mild relative to what we have already experienced. Investors realize that stocks are still one of the best investment choices for the long haul, and this would be an opportunity for many portfolios to increase exposure to equities again to more normal levels.
Holger Berndt, CFA
Director of Research
hberndt@rssic.com
