In my Viewpoints commentary from mid-March, we were in the throes of a record selloff with a drop in asset prices across all asset classes. The COVID-19 pandemic was firmly entrenched in the northeast United States and spreading quickly. The focus was on finding ways to flatten the infection curve and provide support for overloaded medical facilities. The U.S. equity market reached its low on March 23, notching a 34% drop in a little over a month. That was the steepest drop in equity prices in the shortest amount of time in the history of the U.S. markets. The decision had been made to shut down the economy of the United States in order to hinder the spread of the virus. This is the first time in history that the U.S. shut down the economy to deal with a pandemic. The pandemic hit the U.S. economy no less impactfully than a military attack on our country from an enemy that we were ill prepared to engage.
The summation of my last Viewpoints was a look back at the last pandemic to hit the U.S. and the short-term and longer-term effects on our equity markets. We looked at the Spanish flu pandemic that came to the U.S. in 1918 which claimed a much higher toll on the global population. The Spanish flu infected 27% of the world population and killed ~50,000,000 people. Vaccines, as we know them today, didn’t exist back then and medical care was sketchy at best. The point of the comparison was to show that we had seen this movie before. In 1918 – against a backdrop of a pathogen that was attacking a large swath of the U.S. population while also being embroiled in World War I – the Dow Jones found its footing long before cases peaked and began a two-year bull market that lasted firmly into 1919.
Fast forward and what do we see now? Eerily, we see the same pattern that we saw in 1918. The equity markets bottomed on March 23, long before the number of cases or deaths had peaked. The recovery has indeed been remarkable. What we don’t hear much about is that the recession that the National Bureau of Economic Research (NBER) has declared that began in February is likely over. Both the bear market that we experienced this year as well as the short, but deep, recession have likely given way to a new bull market that will likely be with us for months or years to come.
There is a contrary argument that this bounce off the March lows is just a “dead cat” bounce and that we will resume the downward spiral in asset prices as soon as the markets figure out that a “V” recovery isn’t in the cards. We respectfully disagree with this view, witnessing many of the indicators that show a new bull is beginning and that allocations should likely be revisited.
Indicators that the recession is likely over and a new bull is born:
- Recessions traditionally have been an indicator of a new bull market, not the end of one.
- The Fed and Congress have applied trillions of dollars in market support and fiscal stimulus, the magnitude of which is many times anything previously done in history. The fiscal stimulus has been aimed at keeping employees on the payroll or calling back furloughed employees.
- Global central banks and governments have been equally willing to apply massive fiscal and financial support.
- The government caused the recession by shutting down the economy to slow the spread of the virus and by June most states have begun reopening their economies.
- Unemployment claims seem to have peaked in May and are rolling over. Although the number of unemployed in the U.S. eclipsed 40 million people (a record), each of those unemployed is receiving enhanced unemployment benefits. Additionally, cash payments of $1,200 or more to most Americans was reflected in a RISE in personal income of 10.5% in May versus an expected drop of -5.9%. The extra money was reflected in the savings rate that exploded to over 33%, showing most of the money went in the bank instead of being spent.
- Non-farm payrolls experienced a surprise gain in May of 2.5 million jobs versus estimates of a loss of 5 million jobs.
- From the lows on March 23 we have seen a reversal in leadership in the markets. From the low, the former leadership of Utilities, Staples and Technology have given way to new leadership of Energy, Consumer Discretionary, Materials and Financials:
- Percentage gains from the lows on March 23, 2020 to June 9, 2020. (Source Bloomberg | Past performance is not indicative of future results.)
- New Leadership
- Energy ETF (XLE) +92.53%
- Basic Materials ETF (XLB) +54.83%
- Industrials ETF (IYJ) +53.03%
- Consumer Discretionary ETF (XLY) +51.79%
- Financials ETF (XLF +48.89%
- Old Leadership
- Technology ETF (IYW) +45.91%
- Healthcare ETF (IYH) +39.65%
- Utilities ETF (XLU) +36.89%
- Consumer Staples ETF (XLP) +24.68%
- Although the leadership is only a few months old, it is the change from growth to cyclical that we would expect to see at the start of a new bull market.
Moving forward we would expect the 1918-1919 playbook to continue to pan out as the markets detected the end of the pandemic much in advance of a reduction in the number of infections and mortality rate. Remember, two-thirds of U.S. GDP is consumer spending. If the reopening economy and massive stimulus continues to re-employ the millions that have been furloughed, then the bounce back and strength of the recovery should continue. Also, the Fed and Congressional stimulus should continue to be applied over the next couple of years.
We are seeing similar trends in International Developed and Emerging Markets. Our supposition for some time has been that International Markets will catch up to the U.S. markets as many began reopening their economies a month or two ahead of the U.S.
As the 1918-1919 playbook plays out it might be time to adjust portfolios for the future. For those who have been positioned in defensive areas of the markets, it might be time to think about an allocation to more cyclical value plays that have shown some recent leadership. As always, we favor a gradual change to asset allocation versus more sudden changes from one part of the markets to another.
CRN: 2020-0604-8341 R
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