Market Commentary - July 2020

Monthly Update

In July, equity markets continued their rebound rally, which marks the 4^th straight month of gains following the difficult February and March time frame[1]. The sharp rise in COVID spread in states such as California, Texas, and Florida did nothing to dissuade buyers. That is either because there is hopes that a vaccine will come soon, or we are learning to live with it. The equity rally continues irrespective of the economic impact of COVID, which remains profound. Fed liquidity continues to flow like a waterfall and that also is helping sentiment and encouraging risk taking in almost everything.

The bond market has also been a beneficiary of Fed policy, particularly the corporate side. Investment grade bond yields are now below 2%, the lowest ever[2]. The Barclays high yield index has a yield to worst of just 5.4% as of this writing, the lowest since February, even though the world is quite a different place today[3]. That is no longer high yield, even though default rates are rising. The Fed, again, has created a voracious search for yield with their zero interest rate policy and yield curve suppression via QE. US Treasury yields also continue lower, with record low yields seen across the curve[4]. I believe part of this is the lackluster economic picture the Treasury market has relative to the seemingly ebullient stock market.

Coincident with the business reopening’s around the world, the global economy continues to improve, but as seen in July across the US, COVID flare ups are happening, resulting in more stunted growth. Also, as we approach the fall and more people are back inside, there is very limited economic visibility for how things play out in the coming months.

The Stock and Credit Markets

While all areas of the stock market rallied in July, including small, medium, and large sized companies, the impressive rally in large cap tech stocks continues to be eye opening. The market cap increases are truly extraordinary. On July 31^st, the day after Apple reported better than expected numbers, its one day market cap rise was about $180b[5]. For comparison, Nike has a market cap of about $150b and McDonald’s is around $145b[6]. Combined, Apple, Amazon, Facebook, Alphabet, and Microsoft make up more than 20% of the S&P 500[7]. In just four hours of trading one day in July, Tesla added the market cap of Ford[8].

As stated earlier, investors also piled into corporate bonds encouraged by the investment grade corporate bond buying by the Federal Reserve. The Fed buying the bonds of Apple, Berkshire Hathaway, Amazon and McDonald’s is a huge mistake I believe because it is distorting market pricing and there is no shortage of private buyers for these quality bonds. Nonetheless, it has dramatically lowered credit spreads across the spectrum of corporate bonds. The purchases of Treasury and mortgage backed securities continues to melt away the yield curve, in turn helping to send mortgage rates to record lows[9]. It is making it virtually impossible for savers and investors to achieve any yield with low risk, though. It is also making the business of banking very difficult as net interest margins are getting squeezed. Lunch is not free here.

The Economy

The US economy contracted by 33% in the 2^nd quarter when annualized, a shocking number, but one that was entirely self-inflicted[10]. It’s what happens when we voluntarily shut down most of the entire world’s economy. The question then is what kind of rebound we are going to have as things reopen which remains to be seen. Growth will increase in Q3 and likely Q4, but there is still a large hole of which to climb out. Difficulty with managing the virus also is not helping.

The rest of the world also saw sharp economic declines in Q2, but will also see a recovery in the coming quarters. It’s even possible the growth could be better in Asia and Europe when compared to the US, because of the better success those regions have had in controlling the spread of COVID.

The particular hopes with the European economy is predicated on not just a slowdown in the spread, but the possibility of the passage of a 750b euro fiscal spending package, which will consist of a combination of loans and grants. Europe essentially decided to a fiscal union where each country is responsible for the debt taken on to cover this spending.

China’s economic recovery is helping the Asian region, but more so China itself, as its economy shifts to more consumer and domestic based. For sure, China and other Asian nations have seen a much more limited pace of COVID spread, and much of that is because of a greater discipline in wearing masks.

The Government 

As of this writing, we await an agreement of some sort between Republicans and Democrats to spend another $1 Trillion plus, with the money going to a variety of places. The variation of areas includes individuals/households, businesses, schools, and state and local governments. This will follow the $3 Trillion spent in the previous spending plan. The US government continues to try to fill the economic hole created by the pandemic. The part of the package that markets are most focused on is to what extent the unemployment benefits will get extended. The Democrats want to continue with the added $600 per week, on top of the existing state benefits, while the Republicans want something that is based on one’s prior income. With 30 million people currently receiving benefits, the difference is big money[11].

The US Dollar and Precious Metals

The weakness in the US dollar in July was notable as the euro heavy dollar index fell 4.2%, the biggest one month decline since September 2010[12]. The reasoning is a combination of factors. Firstly, the huge amount of Fed money printing (annualized pace of $1 Trillion after a huge amount already done since last September) is reducing the purchasing power of the dollar[13]. Secondly, exploding US debts and deficits is also an anchor on the value of the dollar. In the 12 months ended June, the US budget deficit was 14%, exceeding the 10% in the depths of the previous recession[14].

This dollar weakness, along with currency debasement happening around the world, helped to lift the precious metals in July. Gold was up 9% and higher for the 5^th straight month[15]. It traded at a 5000 year record high[16]. Silver finally joined the rally, after badly lagging gold, by rising 30% in July[17]. Gold is money and when fiat money is being so disrespected by the world’s central banks, it should be no surprise it is trading as well as it is. Silver is also money, but about half the demand is for industrial uses that is now benefiting from the economic recovery.

Conclusion 

When looking at the economy in the US and around the world, the impact of COVID remains obvious and extremely challenging. It could take a few years before the level of GDP gets back to where it was in the fourth quarter of 2019. However, this hasn’t stopped the incredible rally in risk assets, but a lot that help is via aggressive monetary and fiscal policy. At some point, though, we will need to see the handoff from the artificial stimulus to actual organic economic growth. Hopefully, a workable, mass marketed vaccine will get us there sometime in early 2021.

In the meantime, business will be bumpy and uneven, and the Fall will bring even more uncertainty, especially depending on how many schools reopen. Regardless, it is vital that investors have a plan that suits their short term liquidity needs over the coming 24-36 months. Knowing this is covered can help cushion the balance of one’s portfolio against what I believe will be a continued choppy time both for the economy and markets. This is hopefully a once in a lifetime experience that doesn’t just solve itself in a few months. Please do not hesitate to reach out at any time with questions or for any discussion on the economy and markets.

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