Week 21 Sitrep

U.S. stocks markets continued the month-long game of ping pong this week. The S&P 500 Index has bounced between 2800 and 2950 for the last five weeks but cannot seem to find a reason to go beyond either level. The “tug of war” between market fundamentals and hope for a return to normalcy seem to pull markets up and down with high volatility. The VIX Index, the market’s primary measure of volatility, remains near 30 after spending most of 2019 below 15. All the major stock indexes gave up ground last week despite two intraday market rallies on Thursday and Friday.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/18/20

 

We continue to see disparity between indexes like the S&P 500 and individual sectors and asset classes. The S&P 500 is down more than 11% for the year as of Friday, yet the returns of various asset classes and sectors differ greatly from the index itself. The technology and health care sectors are near breakeven for the year while financials and energy are a drag on the index. The leading sectors have moved higher off their lows from March but have recently been struggling to continue their rising pattern. We believe this challenge is not causally related to the sectors themselves, rather the index has hit an important technical resistance level near 2950.1

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/18/20

 

The damage to the U.S. economy from the shutdown has been severe. Recent reports show the fastest decline in economic activity and the fastest increase in unemployment in U.S. history.2 Our economic measures are at levels not seen, even during the Great Depression. The New York Fed releases a weekly growth tracker to measure short-term data such as mortgage purchase applications, gasoline demand, and intermodal rail traffic. The running average for the second quarter shows a decline of 11.1% compared to the year before.3 Our economy has a long way to go before returning to normal.

Source: Bespoke Investment Group, The Bespoke Report, 5/15/20

 

However, recent statistics help us to see that local economies are starting to reopen. Early reports showed consumer spending dropping 30% year over year while recent surveys show only a 20% decline.4 We call that a relative improvement! Bespoke Investment Group shares that Apple Maps reports higher “route requests” for drivers over the last three weeks.5 We realize that as economic activity begins to rise that corporate earnings will start to rise as well. These are early indicators and show that we will need to know more about people returning to work. It is unlikely that 30 million unemployed workers will be able to find stable employment at comparable levels in the next few months. We could be looking at a multi-year recovery.

Source: Bespoke Investment Group, The Bespoke Report, 5/15/20

 

The Federal Reserve has unleashed a tsunami of monetary support for the U.S. economy over the last two months. They have reduced interest rates, increased the money supply and begun purchasing bonds and ETF’s to support the markets.6 It seems very necessary in the short term for the Fed to act in this capacity but it opens up a number of questions about how they intend to step back when the markets begin to function normally. The last time the Fed offered this kind of support it took several years to unwind. The size of the Fed balance sheet has dwarfed anything in recent history and Congress appears ready to continue their recent spending spree as well. We will have to answer the key questions about future tax rates and expected inflation rates in due time. Inflation rates are currently benign.

Source: The St. Louis Fed, FRED Economic Data, 5/18/2020

 

This week typically marks the end of quarterly earnings reports as the major retailers, including Wal Mart, will be providing results. The net result, as expected, is the largest decline in quarterly earnings since 2009 with average S&P 500 earnings down more than 13%.7 John Butters of Factset Insight shared that the average stock price movement after earnings announcements was unusual this quarter. Despite the drastic reduction in earnings, the average stock saw its price jump higher than average on positive earnings results. More important, the average stock with negative earnings saw its price decline less than average. Butters believes the surprise reaction is largely due to analysts lowering earnings expectations much more than was actually realized. It turns out that 65% of companies actually delivered earnings better than was forecast.8

Source: Factset Insight, John Butters, 5/15/20

 

The core tenet of our investment process is the management of risk. We routinely discuss the significance of being able to reduce risk in areas of the market that do not look favorable. Our investment committee had decided to eliminate several investment categories over the last year that resulted in superior risk-adjusted returns for many clients. For example, our portfolio did not own anything in international stocks or U.S. small company stocks. Many of our largest holdings have performed quite well against the S&P 500 Index. The chart below shows the S&P 500 Index in red, QQQE in blue, MTUM in green and XLG in purple (three of our larger holdings in client portfolios). The greatest disappointment in the recent market downturn was the resulting selloff in bonds. Bonds historically act as a buffer for volatility in stock market corrections.

Source: Stockcharts.com; 5/18/2020

 

Our market indicators took a decidedly mixed tone last week when markets sold off. The short-term indicator plunged 10 points to a negative position. Recall that our short-term indicator measures demand trends for all 36 industry sectors and subsectors. The prior week saw all 36 sectors in strong demand mode while last week saw that number cut in half. The intermediate indicator remains negative and cannot change until July 1st. The long-term indicator, as well as the BOSS indicator, remain in favorable territory. The current mixed readings put us in a neutral position for portfolio risk.

 

There was little change in interest rates last week as the 10-year U.S. Treasury Bond closed at 0.64%. The future direction of interest rates will partly depend on the confidence investors have in the Fed’s ability to reflate the U.S. economy. We will be watching corporate bond rates over the next few weeks as the Fed has recently begun its program to buy corporate bond ETF’s. There will be an interesting balance between companies needing to issue more bonds to borrow funds and the Fed’s ability to absorb the supply. The Fed would prefer to keep interest rates subdued at this time to aid in economic recovery.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/18/20

 

We shared Bespoke Investment Group’s study of traditional “brick & mortar” retail stores compared to the “clicks” of online shopping a few months ago. The trends over the past few years were unmistakable showing that online shopping was gaining ground on the traditional stores. The economic shutdown solidified all perceived benefits of online shopping and created a record gap between the two. However, the other trend we had seen witnessed a sharp reversal. Bespoke has shown that stronger economies usually benefit bars and restaurants as consumers are willing to share more of their wallet eating out. Obviously with “dining-in” options being closed the share of total sales at bars and restaurants recorded its lowest reading ever while sales at food and beverage stores shot to the highest level since the early 1990’s.9

Source: Bespoke Investment Group, The Bespoke Report, 5/15/20

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935 or send an e-mail to cameron.malott@engravewealth.com. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:
1. Saut Strategy, Andrew Adams, Trading Flash, May 15, 2020
2. Bespoke Investment Group, The Bespoke Report, 5/15/20
3. Bespoke Investment Group, The Bespoke Report, 5/15/20
4. Bespoke Investment Group, The Bespoke Report, 5/15/20
5. Bespoke Investment Group, The Bespoke Report, 5/15/20
6. Bespoke Investment Group, The Bespoke Report, 5/15/20
7. Factset Insight, John Butters, 5/15/20
8. Factset Insight, John Butters, 5/15/20
9. Bespoke Investment Group, The Bespoke Report, 5/15/20

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