“Monetary conditions exert an enormous influence on stock prices…Don’t fight the Fed.” – Martin Zweig
Review & Outlook
The stock market has behaved like a roller coaster for the first six months of the year. In our last quarterly letter at the end of March we recommended that everyone stay calm and stay the course after the ruthless stock market decline during the first three months of 2020. At the time, we stated “Attempting to time the market is futile and will likely lead to significant damage to potential long-term rates of return.” Even though it was difficult to maintain clarity at the end of the first quarter, that mindset prevented temporary loss from becoming permanent loss.
Earlier this year on February 19th the S&P 500 index reached a new all-time high. But less than a week later, the market started reacting to the dire coronavirus news, thus causing the market to decline over 34% in just five weeks resulting in the fastest bear market decline on record. Bear markets are defined as a 20% fall in the stock market from current levels, and they typically occur about every four to six years depending on the historical data set observed.
To mitigate the market damage, in early March the Federal Reserve reduced its benchmark interest rate to near zero. On the morning of March 23rd, the Federal Reserve stated that it would do essentially whatever it takes to stabilize the markets and help the economy recover. Not coincidentally, the S&P 500 index low point this year was hit that same day, which set the stage for what would become the fastest recovery from a bear market in history. We saw a rapid gain of 17.6% in the S&P 500 over the ensuing three days, pointing out once again why it is impossible to time the stock market. Since March 23rd, the S&P 500 gained 38.6% through the end of the second quarter. In fact, the second quarter finished as the best quarter in the stock market since 1998.
The question on everyone’s mind is how the stock market can do so well in such uncertain and tough economic times. It is typically never one reason alone that causes stock market fluctuations. Therefore, there are many possible reasons such as the following:
- Monetary Support: The Federal Reserve has been unwavering in its support of the economy during this pandemic (i.e. Don’t fight the Fed). The Fed initiated many new lending facilities for American businesses and said it would purchase unlimited amounts of government backed debt. The Fed has even ventured into supporting corporate credit through the purchase of bond ETFs and individual corporate bonds. During the second quarter, the Fed expanded its balance sheet to $7 trillion, and some predict that could grow to $12 trillion by the end of the year. That level would be approximately 50% of US Gross Domestic Product. Along with the massive stimulus in the United States, many other countries around the world followed suit.
- Fiscal Support: Congress has provided an unprecedented level of financial support directly to individuals through extended and enhanced unemployment benefits as well as direct monetary payments to certain individuals. Congress has also provided substantial support to the small business community through loans and grants, thus encouraging companies to maintain payroll through the pandemic.
- Reopening the Economy: The coronavirus infection and hospitalization curves significantly flattened across the country over the past three months, which allowed the economy to begin a reopening process. However, we are now seeing some new hot spots popping up across the country. Thus far, the stock market has not reacted negatively due to the expectation the economy will not need to be shut down again.
- Therapeutics and Vaccine: There are currently 17 drugs in human clinical trial testing phases, with four exhibiting positive results. The world has the best scientific minds and medical companies working non-stop on a solution. This provides real hope that a therapeutic or vaccine could become available sooner than originally thought. According to ABC News, during a late June testimony in front of a House committee, Dr. Anthony Fauci was quoted that he is “cautiously optimistic” that a vaccine could be ready by the end of the year.
- Forward Looking Market: Investors are willing to look ahead to a better economy and corporate earnings picture in 2021 and 2022. According to a recent Wall Street Journal article, approximately 35% of companies in the S&P 500 have withdrawn their earnings guidance for 2020 based on data from the financial data firm FactSet. This makes it more difficult to value stocks in the near term. But the FactSet data also shows that analysts predict corporate earnings to rebound in 2021. The US Gross Domestic Product (GDP) will also dip this year due to the virus. However, according to Bloomberg, recent GDP forecasts predict the economy will return to the pre-pandemic level by the third quarter of 2021. Therefore, investors are focusing on better results being attained in the next two years.
The Federal Reserve and Treasury have gone to unprecedented lengths to prop up the economy, businesses, and consumers as much as possible. In late March, Fed Chairman Jay Powell reassured the market when he said during an interview on NBC’s “Today” show, “When it comes to this lending we’re not going to run out of ammunition. That doesn’t happen.” About a month later, at the Federal Open Market Committee meeting press conference, Powell confirmed the Fed would continue to do “whatever we can and for as long as it takes” to support the economy and markets. Then in early June, the Fed stated no plans to raise interest rates through the end of 2022 when Chairman Powell famously said, “We’re not even thinking about thinking about raising rates.”
The rally experienced over the past three months highlights how the stock market is always looking ahead to the future. Rather than focusing on some of the grim economic news of today such as the high unemployment rate, the broad market continues to focus on the recovery in the economy and higher corporate earnings in the future. The issue is not whether the stock market and economy will rebound, but when. Some economic statistics have started to improve, notably the surprisingly large increases in May and June nonfarm payrolls reported by the Bureau of Labor Statistics, as well as the sharp rebound in May retail sales. Let us hope the recent spike in coronavirus cases will mitigate over the rest of the year as people continue social distancing where possible.
Just as we said in our last quarterly letter, we encourage you to be safe, patient and enjoy your time with your family. Reach out to friends and family on the phone to comfort them and take a break from the news cycle. Please feel free to reach out to us with any questions. We look forward to better days to come.
Marietta Wealth Management, LLC