‘’History doesn’t repeat itself, but it often rhymes.” Mark Twain

An historic quarter in many respects. A Pandemic. Race Riots. A Trade War. Political Chaos. Yet the market so far looks like a “V” recovery. The best quarter since 1998. While the economy appears more like a “U” or an “L.” So either the economy needs to kickstart and catchup, or the market is due for a pullback. Economic forecasts have mostly been pessimistic and way off the mark. Distortions caused by massive stimulus, consumer and business caution, as well as COVID uncertainty make predicting even more unpredictable.

The most candid economic commentary I’ve heard was “we economists don’t have a clue what’s going on right now.” So, what’s buoying the market? Low rates, stimulus money, or how about those Robinhooders?!?

Robinhood Day Traders to the Rescue

These rookie retail traders are betting on pure momentum. No concern for earnings, estimates, or products. Robinhood makes the “research” even easier by posting its users top holdings. The clueless following the clueless. Chasing bankrupt companies like Hertz and Chesapeake Energy whose stock may end up worthless. Anybody else remember the dot.com “new economy” and all the genius day traders of that era?

Like the geniuses of yesteryear, they’re leveraging cash with option contracts and margin debt to boost their buying power. The problem with options is that when you’re wrong, you can lose 100% of your investment. The problem with margin debt is that when you’re wrong, you can lose more than 100% of your investment. With no clue about downside risk these “day traders” road to riches is exponentially clueless! This won’t end well.

Interest Rates: Bonds Provide Stability, but Not Much Income

The table below shows that interest rates have gone from low to lower. In March, investors moved money into cash and bonds for safety. Rates have declined 45%-90% on US Treasuries since the beginning of the year (good if you’re mortgage shopping). Typically, as stocks rebound rates increase. They haven’t. This may be a clue worth keeping in mind as the deflationary theorists’ note.

US Treasury Rates 2020

To get a higher rate than Treasuries, means owning corporate bonds with higher credit and default risk. Given the economic uncertainty, it’s a key consideration. To ensure corporations have adequate funding, the Federal Reserve has said it will buy corporate bonds, which helped to calm the market. Recently the Fed better defined program parameters. They are designing an index of mostly investment grade bonds. Up to $750 billion. Thus far they’ve only purchased $9 billion.

How will economic activity resume when the stimulus cookie jar is removed?

The world has seen pandemics before, but never one where the global economy was shutdown. There’s no playbook for comparison. Corporate profits are projected to be down 30% in 2020 and back to 2019 levels in 2021. Of course, 2021 will depend on COVID’s impact and how well the economy can function until a vaccine is in place.

The chart below shows savings rates spiking from 7% to over 30%. The bullish view is there is a lot of money in savings accounts waiting to be spent that will drive economic activity. The bearish view is that employers may not be willing or able to bring all their workers back. The unemployment rate currently stands at 11%. Hence, caution and lower spending.

US Savings Rate

 

Some Encouraging Signs

• Bank chiefs in the US and Europe are saying the “worst is behind us” and that delinquency rates are much better than expected.
• Home equity is strong which helps to bolster consumer confidence. Housing supplies are tight and interest rates are low.
• Valuations aren’t cheap, but they aren’t in dot.com bubble territory when PE ratios on tech companies were near 90! Which lead to ten years of poor returns in US large cap companies.

 

Asset Class Review

The S&P 500, still down for the year, is up 35% from market lows; the tech heavy NASDAQ up 17% for the year, and 46% from the lows. Big tech accounts for almost 25% of the S&P capitalization and has driven most of the
returns in the S&P. Small stocks tend to fall further in recessions and that has held true in this cycle.

International stock markets were mostly in line with the US though lacking the strength of the technology sector. Several countries have better managed the pandemic and are starting to see some renewed economic activity.

REITs usually do well when rates decline. However, the retail, healthcare, and hospitality sectors have been very hard hit and hurt the overall benchmark. Several companies were forced to cut dividends and renegotiate leases.
The long-term impact of COVID remains to be seen.

In the commodities sector, oil was the big story falling briefly into negative territory on a technical and timing issue. Gold was up 15%. Copper was up 32% in the quarter and reached its prior peak levels.

Bonds, led by US Treasuries, provided stability and the only sector with gains for the year.

 

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