Weekly Investment Newsletter (SITREP) – June 1, 2020

The Weekly SITREP – June 1, 2020

Bad news surrounds us on every side – the economic shutdown is barely letting up; corporate earnings are abysmal, and we are experiencing protests and riots across the country. We are appalled at news of the unnecessary death of George Floyd and evidence of outright racist bigotry in 2020. As a nation, we must rise above such ideology and embrace the principles of freedom that made this country great!

Strangely, the U.S. stock market does not seem concerned about any of these events and continues to rise on expectations of future growth. We are perplexed with current market results as they are not explained by any traditional measures. Current valuations (P/E ratios) for stocks are extremely elevated since prices have risen while earnings are falling. Yet the market moves up – last week by more than 3% for the S&P 500.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 6/1/20

 

There are stark differences in the various indexes this year. The S&P 500 is now down nearly 5% for the year while the Dow Jones Industrial Average is down more than 10%. Yet the NASDAQ Index is up more than 5% while international equity indexes remain lower by nearly 15%. This has been a difficult year for value companies of all sizes despite the better returns over the last two weeks. The most downtrodden U.S. stocks continued to rebound last week as financials, industrials and real estate led markets higher. Many analysts believe this trend may be challenged as future growth prospects for those sectors are in question.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/25/20

 

As mentioned above, recent trends in market returns have changed over the last two weeks as the most beaten down stocks have rebounded. While technology, health care and communication services companies went down less than the market in February and March, those sectors also led the market higher in April and May. Since May 15th, the companies that were hit the hardest in March and April have been leading the index higher. However, recent performance has led to exorbitant prices in most sectors. According to Bespoke Investment Group, 96% of S&P 500 sectors are trading above their 50-day moving average, a level last seen in 1991.1

Source: Bespoke Investment Group, The Bespoke Report, 5/29/20

 

Recent market reactions have also sent 100% of S&P 500 Industry Groups above their 50-day moving average with continually rising moving averages.2 This has been a challenging market for investors as we have seen extremes on both sides over the last three months. As recent as April we saw 0% of S&P 500 Industry Groups above their 50-day moving average.3 The massive volatility has made investing difficult over the last three months, especially compared to the low volatility and calm markets from 2019.

Source: Bespoke Investment Group, The Bespoke Report, 5/29/20

 

Clearly, investors are perplexed as to why markets have risen so dramatically since March 23rd. The expectations for future economic growth and corporate earnings growth are dire. The Atlanta Fed now projects a decline in economic growth of 53% for the second quarter.4 We also received reports from the Bureau of Economic Analysis that consumer spending suffered another 14% decline in April after falling 7% in March.5 Consumer spending is a major component of U.S. GDP growth. We expect to see improvement in May and June reports but it may be a slow recovery.

Source: Bespoke Investment Group, The Bespoke Report, 5/29/20

 

One great challenge facing investors over the next month is the lack of transparency from U.S. companies regarding 2nd quarter earnings expectations. Most U.S. companies are not offering guidance on earnings for next quarter leaving analysts to surmise what to expect. The result is that analysts are expecting the worst change in annual earnings (down 28%) over the first five months of the year since the data started by Factset in 1996. For perspective, the average decline in earnings expectations over the last 20 years is down 2.4%, and the worst recording prior to 2020 would have been in 2009 when earnings were lowered by 26.4%.6

Source: Factset Insight, John Butters, 6/1/20

 

For anyone wanting to play the optimist, lower interest rates have given way to lower mortgage rates for homeowners. As home inventories have recently declined, the national average for a 30-year fixed rate mortgage is currently at 3.57%. Mortgage purchase applications have risen each week for the last six weeks, tying the record for the longest streak of weekly increases.7 The lower rates bode well for a strong traditional home-buying season between April-May. The slowdown from the economic shutdown may mean the homebuying season gets extended beyond normal measures.

Source: Bespoke Investment Group, The Bespoke Report, 5/29/20

 

We have literally gone from sour to overripe with our market indicators over the past three months. Although the longer-term indicators remained positive, March and April saw three of our four indicators turn negative. The extremely quick rise in stock prices has sent all four indicators back to positive readings and the short-term indicator has maxed out at 36/36 sectors and subsectors of the market showing demand. Even the quarterly trend indicator appears to be shaping up for U.S. stocks as it recently changed to point towards a positive reading for the end of the quarter. The speed at which this has happened makes it difficult to adjust portfolios quickly enough. We would also note the extreme volatility in the short-term indicator over the last few months, which hurts our ability to adjust portfolios for new money being invested.

 

Perhaps this should be the lead paragraph in the SITREP going forward. The bond market is in strong disagreement with the stock market over what to expect in the near future. While stocks appear to be pricing in a massive economic recovery, the bond market is more reluctant. If the bond market believed that Fed intervention and government spending is going to create future growth, we would expect to see interest rates of all maturities rise on the news.

However, all rates appear to be holding steady in their range over the last 30 days. Either the bond does not believe the economy will recover quickly or the Fed has been able to purchase enough bonds and bond ETF’s to keep interest rates at bay. Time will tell which one is correct!

Source: J.P. Morgan Asset Management, Weekly Market Recap, 6/1/20

 

Many of you are familiar with an old stock market axiom that says, “sell in May and go away”. That saying originated from the idea that market activity is slower between June and September making returns harder to find. Bespoke Investment Group’s monthly seasonality readings will confirm that June is historically not a great month for the markets.8 Given the extreme challenges in March and April, we could see a different outcome this year.

To be clear, our investment committee continues to be amazed at the scale of the recent increase in stock prices despite deeply negative readings for the economy and earnings. It is hard to describe what could have caused the recent returns except to say that investors appear to believe that the Fed is able to prevent any negative consequences of a recession or bear market. We continue to see heightened risk in many areas of the markets and believe that the next few months could be very volatile going into the November elections. We have positioned client portfolios to protect from those uncertainties but still benefit if we see a quick recovery. We are happy to offer more details over a virtual meeting or phone call.

Source: Bespoke Investment Group, The Bespoke Report, 5/29/20

 

If you would like to schedule time to discuss our process in greater detail, please call our office at (281)616-5935 or send an email to Cameron.malott@engravewealth.com. We are continually grateful for the confidence you have placed in our team. We look forward to serving your family in the years to come!

 

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:

1. Bespoke Investment Group, The Bespoke Report, 5/29/20
2. Bespoke Investment Group, The Bespoke Report, 5/29/20
3. Bespoke Investment Group, The Bespoke Report, 5/29/20
4. CNBC.com, Jeff Cox, “GDP is now projected to fall nearly 53%…”, June 2, 2020
5. Bespoke Investment Group, The Bespoke Report, 5/29/20
6. Factset Insight, John Butters, 5/22/20
7. Bespoke Investment Group, The Bespoke Report, 5/29/20
8. Bespoke Investment Group, The Bespoke Report, 5/29/20
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