| In almost a tale of two cities, protests and looting have emerged in over 100 cities across America over the past week for George Floyd, a man who tragically died in Minneapolis police custody, on May 21. And yet despite the widespread civil unrest, this morning’s job market surprise of 2.5 million jobs created in May has capped a week with markets ticking higher throughout. This 50-day rally on the S&P 500 has outpaced any such prior period for the last 50 years. We are no doubt witnessing strong resilience of the U.S. economy. While this is proving to be a very painful period of adjustment in American history, and may yet drive an extended period of policy reform, Barron’s provided a succinct analysis this week as to why civil unrest has not been a detractor to market performance.[1] That lack of reaction isn’t surprising in one regard: Wall Street filters most news through the lens of share prices. It’s a voting machine on the future of corporate profits…The first thing Wall Street does when something new and unexpected happens is look to history for precedents. In this instance, that exercise sends analysts back to painful periods including President John F. Kennedy’s 1963 assassination, the 1965 civil rights march in Selma, Ala., the large 1967 Vietnam War protests in Washington, D.C., the 1968 assassination of Dr. King and the 1992 L.A. riots which broke out in the aftermath of the acquittal of several police officers put on trial for beating Rodney King. What does the reaction to these events show? Historically, the market looks past most civil unrest. Stocks aren’t significantly more volatile in the months following any of the events listed. What’s more, the S&P rose in each year under study. Annual gains, excluding dividends, ranged from about 4% to 20%. At the same time what started as a rally concentrated in a few technology and health care names, more recently has achieved broad-based participation, with 96.8% of S&P 500 companies now outperforming their 50-day moving average; and the equal weight S&P 500 index, which significantly lagged early on, is now since the beginning of the quarter in-line with the more widely-recognized, market cap weighted S&P 500 index. In addition, we are seeing small cap stocks outperform large cap stocks, with the Russell 2000 index up 26.2% versus the S&P 500, up 21.3% through the quarter. Finally, we are seeing a shift in leadership from growth to value companies, with the large cap value index (Russell 1000 Value) outperforming the large cap growth index (Russell 1000 Growth) nearly 2 to 1 for the month, led by the financial sector. As we noted last week, an earlier shift to small cap companies in client portfolios has added value. Maintaining a neutral weight between value and growth is similarly starting to add value within the portfolio. Fixed Income ReviewThe short end of the yield curve continues to remain fairly range bound set by the Fed Funds rate of about 5 basis points (0.05%), but further out on the curve you are starting to see steepening. There are a few factors that play into this. The curve is steepening as optimism builds as states reopen and public health concerns continue at a rate the health care system can handle. As the yield curve continues to build in future economic growth, it is also building in some additional inflation. Although inflation expectations continue to remain muted, the long end of the curve is starting to price in some drift upwards. Long-dated treasury bonds have also become slightly less desirable as the U.S. continues to borrow to fund the massive economic stimulus. The Federal Reserve recently began to openly discuss the concept of yield curve control, which it last used during World War II. This policy calls for the Fed to set targets for the treasury yields and buy as many bonds as necessary to maintain those levels. From initial Fed comments, it appears they will target the shorter end of the curve but leave the long end to float freely. The Fed has been pulling back as an active buyer of treasuries reducing their net purchases, which is also putting additional pressure on long treasuries. In the end, we believe a steeper yield curve is a healthy sign, if done in a gradual manner. If rates on the long end rise too quickly, it will tighten financial conditions, and we would expect the Fed to step back in. The Fed has various tools and has shown they are not afraid to adjust policy when market conditions warrant. In the meantime, we remain duration neutral to the benchmark, and continue to emphasize quality in the portfolio. |
