Commentary on the Market: Second Quarter Update 2020

2020 has been a roller coaster ride so far with the financial markets experiencing and equivalent number of highs and lows. Now that the second half of the year has begun, I thought that it would be appropriate to do a look back at the first half of the year and to provide my perspective.

As we began the new year the stock market continued its rise, and stocks came out roaring with the major indices setting new highs. However, the rally hit a wall when the COVID-19 pandemic appeared, and many countries went on lockdown. Not long after, the U.S. began suffering a similar fate. Uncertainty of how severely we would be impacted by the virus and fear of an impending economic downturn caused violent selloffs in the U.S. financial markets which further triggered panic selling in foreign markets. By mid-March we reached bear market territory with the S&P 500 down 20%.

With stay at home orders being issued to curb the spread of the COVID-19 virus, the U.S. fell into a recession with more than 40 million people unemployed. The impact of so many unemployed caused retail sales to hit record lows; many companies both big and small filed for bankruptcy; U.S. crude oil prices briefly turned negative; the 10-Year Treasury yield fell to a record low of 0.40%. All of this happened in less than 3 months.

Fortunately, the second quarter opened up with the stock market making an amazing comeback and rebounding out of the bear market. The Dow and the S&P 500 surged 40% from their March lows with the Nasdaq hitting 10,000 for the first time. (Let me provide clarity on the percentage rebound. The 40% surge was the move upward from the bottom, not overall growth. If you lose $100 and make $40 of it back, that is a 40% recovery. The indices still have a way to go to get back to previous highs but are making strong progress.)

Overall, it was a wonderful quarter. This also marks the best quarter for the stock market in more than two decades. The rally has been led by technology and biotech as many companies race to find a vaccine and medicines to treat the coronavirus. With the country partially reopening, the economic data indicates that we may be looking at a V-shaped recovery prompted in part by healthy job gains. The Federal Reserve Bank is still predicting a U-shaped recovery and will be keeping key interest rates at very low levels through 2022. The Fed is also enforcing capital restrictions on banks in order keep them healthy and capable of passing the stress tests that were put in place during the Great Recession of 2008.

Also, the recovery was aided by a retail sales jump of 17.7% in May, which included a 44% surge in vehicle sales. The housing market is also recovering, as ultralow interest rates have encouraged Americans to buy or refinance. Applications have increased 10-straight weeks in a row and are now at a new high, 21% higher than a year ago. So, what should we expect for the second half of 2020? This is the time to address the elephant in the room. The economy’s fate, in the short term, is inextricably linked to COVID-19. A strong economic recovery depends on progress made in the overall containment of the COVID-19 virus, allowing for job growth and expansion of the economy.

Apart from that important note, let us look at a few numbers that should give us some encouragement regarding the stock market. The 10-year Treasury is currently yielding about 0.69%, while the dividend paying stocks in the DJIA are currently yielding approximately 3.25%. That is almost 5 times the yield of the 10-year Treasury, making the dividend stocks attractive income instruments and the overall stock market attractive. Although, I do have confidence in an economic recovery and a rebounding of the stock market, I am more in line with the Federal Reserve Bank. The economy will recover, but I do feel that it will be a more U-shaped recovery with some fits and spurts along the way. We will soon be approaching earning season, where the stocks within the S&P 500 will begin reporting the second quarter earnings. The picture appears a bit dim for the quarter with earnings expected to come in weaker than the first quarter.

However, as progress is made in controlling the COVID-19 virus, the economy should begin to further reopen. At that point, we will see a rise in employment, which will spur retail sales and manufacturing to improve, thus creating a positive future earnings outlook. The overall economic picture should brighten.

We will get back to normal. Although, it may be a new normal. It may not happen as soon as we would like, but it will happen. We may not see full or lower unemployment for a few more years. But it will happen. We have history on our side. I remain bullish on the stock market. Companies, like the rest of us, are adapting to a newer version of normal. This has happened throughout the course of history. Keep the faith. We will all emerge stronger.

This month Guerra Investment Advisors celebrates its 25 Anniversary and I am in my 34th year in the investment business. I have seen much during my investment career. We have made necessary changes over time to adapt to the environments that we experience. I remain confident. We will continue to exercise good judgement in the execution of our investment philosophies. We do have history on our side.

Please don’t hesitate to reach out to me with any questions that you may have. I am happy to take your call or email.

 

My best to all,

Ruben E. Guerra