In a nutshell
- The quickest bear market decline in history, followed by a 2nd quarter rally not seen since the 1990’s
- Gold and U.S. Treasury bonds best performers so far this year
- Inflation coming?
U.S. Stocks – What?! Wait. What?!
In January I finished my 2019 end of year review with a comment that historically markets follow strong up years with another solid year “punctuated by a few anxious moments, such as the one we’re going through now with the Coronavirus”.
Talk about an understatement! Following a mostly up first 7 weeks of the year, the stock market posted its fastest bear market decline since the beginning of the Dow back in 1896. From February 19 through March 12, it took only 19 trading days to drop 20% from its high. Then it proceeded to fall another 14% over the next 7 trading days, hitting its low point on March 23. (Sources: LPL, Yahoo Finance)
From there it began one of its strongest rallies in history, finishing up a little over 20% for the 2nd quarter and only 3% below where it began the year.
I think everyone knows why the stock market nosedived so I won’t waste any words on that. A question I get on a regular basis is why the market has rebounded so quickly, especially since we haven’t seen an economy this bad since the great depression.
There are a couple of reasons. First, the market is always trying to look ahead and predict what the economy will do. It’s not anywhere near perfect in doing that, otherwise it would have begun dropping long before mid-February. So right or wrong, in the past few months, the market believes that a vaccine will be available sooner rather than later. And conventional wisdom is once that happens, the economy will recover quickly.
Second, interest rates are at historic lows. This makes stocks (and gold as discussed later) look more attractive relative to bonds.
For example, the interest rate on a 10 year U.S. Treasury bond is currently 0.6% per year. If you take inflation into account, currently around 1.6%, that’s a negative 1% real return. Alternatively, investors can buy a basket of high quality stocks which will pay over 2% per year in dividends. Of course, there’s always the risk that even blue chip stock prices will go down. Currently though, more investors are willing to make that trade-off.
International stocks – Continuing to play 2nd fiddle
Stocks outside the U.S. were hit just as hard in the early part of the year. They have also seen a nice rebound, just not to the same degree. This continues a trend that’s been in place the last dozen years where domestic stocks have outperformed their international counterparts.
According to many experts, international stocks are a much better value than those in the U.S. One day the markets should recognize this and international stocks will take a leadership position again. However, they’ve been a better value for years now and no one knows when that day will come.
Bonds – Mostly as expected, mostly
Typically, during a bear market, government and high quality corporate bonds outperform stocks. That was true this time as well, for the most part.
During the height of the panic in mid-March, even highly rated corporate bonds were subjected to substantial downward shocks. At that point buyers would only put their money in bonds backed by the full faith and credit of the U.S. Government.
During the 2nd quarter stock rebound, bonds held steady for the most part. With interest rates at historic lows and no plans by the Federal Reserve to raise rates for the foreseeable future (Source: CNBC), a growing number of investors are looking at bonds as a safe haven instead of a source of income.
Alternative Investments – Inflation signals?
With the first round of government stimulus having pushed trillions of dollars into the economy, and an expected 2nd round that could add another trillion or more, could higher inflation be on it’s way?
Some experts say the way to tell is to look at commodity prices, typically gold and oil. If that’s the case, they are sending mixed signals right now. While gold has been steadily marching higher this year, oil prices have gone down.
The reality is commodities are impacted by a number of different factors, inflation being only one. For example, lack of demand has hurt oil prices as travel worldwide is well below normal.
The rise in gold may be a response to inflation expectations. Investors could also be seeing it as another safe haven along with bonds. Since interest rates are so low, there is currently no penalty to holding the precious metal compared to bonds. Normally, since gold doesn’t pay any interest or dividends, it’s usually not as attractive to conservative investors. Now however, with government bonds having a negative inflation adjusted interest rate, gold has become a viable alternative. (source: Variant Perception).
While there are usually pockets of inflation, overall, when represented by commodities in general, it’s hard to see inflation risk right now. Per the summary chart, a diversified basket of commodities, which in addition to gold and oil also includes agricultural products and industrial metals, has been the worst performer over the first half of this year, down over 21%.
The first six months of this year is something that none of us will forget, and that’s not even taking into consideration what’s gone on with the markets. That said, we still have another half to go.
While the stock market rally has essentially given the all clear signal, there very well could be some bumpy patches ahead. Over 16 million workers are still unemployed and large swaths of the economy are dependent on people being comfortable around each other.
Oh yeah, there’s also the little matter of a presidential election.