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The equity market recovery that began in late March picked up steam throughout the second quarter. The S&P 500 Index jumped 20%, its biggest quarterly gain since the fourth quarter of 1998. Given extremely depressed investor sentiment, as well as anticipation of massive declines in economic activity, it did not take much to exceed expectations. Investors were encouraged by the reopening of the economy, signs of improvement in economic data, generally positive demand commentary from corporate earnings calls and the speed and aggressiveness of the monetary and fiscal policy response. Optimism surrounding potential COVID-19 vaccines and therapies also provided a positive narrative throughout the quarter.
Fixed income performance was also notably strong. Treasury interest rates were little changed, and generally fluctuated within a tight range, but Federal Reserve efforts to repair bond market function and aggressively boost credit translated to significantly higher corporate bond prices. The fixed income rebound was particularly evident in more credit sensitive segments such as high-yield bonds.
Below is a summary of the performance results for the major indices:
As the second quarter progressed, we saw broad-based economic improvement that the market sniffed out several months ago. Not surprisingly, the start of the economic bottoming process aligned very well with the U.S. and global economy’s reopening. Quarterly highlights included a May retail sales report showing the largest monthly gain on record and solid employment reports reflecting 7.5 million jobs added in the final two months of the quarter. High-frequency indicators also showed a pickup in travel and leisure activity, evidenced by increases in air travel, public transit use, truck traffic, driving-direction requests, restaurant reservations, hotel occupancy, beach visits and vacation rentals.
While we’re encouraged by these improvements, we recognize numerous counterpoints as well. Pessimistic investors make the point that many of these “strong” data points are measured against the lows of one of the largest economic declines in history, and still represent very depressed levels compared to 2019. It is also clear that government stimulus checks and enhanced unemployment benefits have propped up both businesses and households. While the consumer will most likely benefit from additional fiscal stimulus in the near-term, this support cannot last forever, and the reins will have to be passed back to organic, private sector growth at some point. Importantly, the late-June surge in COVID-19 cases in the South and West also raises concerns about the trajectory of any recovery. The uncertain economic and public health backdrop leaves plenty of room for differing views and opinions. Our view is that the worst of the economic plunge is behind us, and that the hurdle for another nationwide economic shutdown is considerably higher than back in March.
We ended the first quarter with a slight overweight position to stocks after adding to equity allocations in mid-March. As we outlined in last quarter’s update, our plan was to continue to add to stocks but in a slow and patient fashion. In hindsight, that approach proved too conservative as equity markets rocketed higher before we fully implemented our plan to step up stock exposure. As the equity market rebound progressed throughout the quarter, valuations and the risk-to-reward proposition became less compelling in our view. As a result, we trimmed back our equity overweight and ended the quarter with a mid-point or neutral stance.
Portfolio performance results were impressive, given the strongest quarterly equity market results in more than 21 years and a continuation of the massive credit market rebound that kicked off in late-March. The second quarter stock surge was very broad-based, with all but two S&P 500 sectors posting double-digit returns.
Below is a summary of some of the factors that benefited results on a relative basis as well as some notable detractors.
Contributors to Performance:
- The equity overweight stance that we maintained for much of the quarter was beneficial as stocks dramatically outperformed bonds.
- After declining less than international stocks in the first quarter, domestic equities significantly outperformed to the upside this quarter. This outcome was another positive contributor to performance results, given our lack of dedicated foreign stock exposure.
- After a dismal showing in the first quarter’s “risk-off” environment, preferred stocks snapped back aggressively with performance results handily outpacing core bonds.
Detractors from Performance:
- The financial and healthcare sectors posted solid absolute returns but were relative laggards compared to the broad market index.
- Growth stocks were the clear leader in the second quarter, outperforming value-oriented equities by a massive 14 percentage points. While we maintain some growth exposure, more would have been preferable given the massive outperformance of this segment of the equity market.
During the depths of the first quarter market plunge, we discussed our view that the stock market would rebound well before the economy improved or COVID-19 was contained. History has taught us that equity markets do not wait for all the bad news, economic fallout and earnings declines to end before looking to the future. This time was no different.
The S&P 500 Index bottomed on March 23rd, a day when the cumulative global COVID-19 case count was less than 380,000. We’ve now passed 13 million cases worldwide, after suffering one of the largest economic contractions in history. Aggregate second quarter earnings are expected to decline by more than 40% in the United States. Despite all this dreadful data, the S&P has rocketed higher, up roughly 40% from the March low and within sight of all-time highs. While the disconnect between the current gloomy state of the economy and the extraordinary equity market rally is apparent, it aligns well with the “move on” phase we discussed last quarter.
It feels like stating the obvious that thus far 2020 has dealt us unexpected events, extreme volatility and uncertainty around every corner. And we’re only halfway through the year! Developments over the last six months highlight the importance of sticking to a well-grounded investment plan in good times (like the second quarter) and bad (like the first quarter). Aligning our investment decisions with our clients’ long-term strategies and time horizons has served us well in the recent turbulence. It certainly wasn’t comfortable, but successful investing rarely is.
Roof Advisory Group (“Roof”) is a division of Fort Pitt Capital Group, an investment advisor registered with the United States Securities and Exchange Commission (“SEC”). For a detailed discussion of Roof and its services and fees, see the Form ADV Part 1 and 2A on file with the SEC at www.adviserinfo.sec.gov. Registration with the SEC does not imply any level of skill or training. You may also visit our website at www.roofadvisory.com.
Any opinions expressed are opinions held at the time of publishing and are subject to change. It does not constitute an offer, solicitation or recommendation to purchase any security. The information herein was obtained from various sources; we do not guarantee its accuracy or completeness. Past performance does not guarantee future results. The performance shown is for illustrative purposes only and the intent is to show the performance of certain segments of the fixed income markets. This information is not reflective of the performance of any Roof client, or the impact of security selection on actual client portfolios.
The S&P 500 is a broad-based index of 500 stocks, which is widely recognized as representative of the equity market in general. MSCI EAFE™ Index is designed to measure the equity performance of developed markets outside of the U.S. and Canada. The MSCI ACWI™ Index is a market-capitalization-weighted index designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based index of intermediate term investment grade bonds traded in the U.S. The Bloomberg Barclays™ Municipal 1-5 Year Bond Index is a capitalization-weighted index representing the aggregate performance of the investment-grade municipal U.S. bond market. These indices are unmanaged and may represent a more diversified list of securities than those recommended by Roof. In addition, Roof may invest in securities outside of those represented in the indices. The performance of an index assumes no taxes, transaction costs, management fees or other expenses. Additional information on any index is available upon request.