Month: July 2020

Education and the reopening of schools came into focus this week. Approximately 40% of households have at least one minor child at home, which has ramifications for the labor market and consumers.^[1] The path to mobilizing 56 million students back to schools is not clear cut, and a number of school districts are in the midst of announcing plans that run the gamut. Earlier this week, Los Angeles announced the decision to remain virtual despite the fact that a third of their students never logged on during the shutdown last spring (Baird-Strategas). The implications for students and families that remain at home are significant, and the pressure has been on to find ways to make education in the classroom a safe reality. The CDC is currently working on a set of new guidelines to help school districts accomplish this in the coming days. About 65% of universities and colleges have already announced their decision to bring students back in the fall, albeit with adjustments and cautionary measures in place.^[2]

In the meantime, cases continue to surge, but mortality rates have remained flat over the past seven days. It is interesting to note that Miami-Dade County, which has been described as the new Wuhan or epicenter of the pandemic, never re-opened its restaurants and bars. California, the first state to shut down, has sought to reinstate a limited lockdown, which will have implications for its local economy. Recent data shows that states that emerged from lockdown earlier have consistently seen lower unemployment rates and faster recoveries.^[3]

The stock market continued its rally this week, as economic data continued to show signs of improvement. At the close of the market on Wednesday, the S&P 500’s year to date return was flat for the first time since the crash in March. The NFIB survey of small business revenue expectations came out this week, showing the fastest snap-back on record, and a near complete recovery since first quarter of this year (see figure).^[4] While it was highlighted recently in the press that 20,000 to 30,000 small businesses have experienced closure this year, it’s important to note that this is a fraction of the nearly 30 million American small businesses.^[5]

Equity

As the sentiment among smaller companies improves, our rebalance in mid-May from large cap equities to the small cap sector is paying off. With Wednesday’s big move in small cap, our small cap sleeve has pulled ahead of both the large cap growth and value indexes, up 19.54% versus 15.27%, respectively, over this time period. Large cap technology enjoyed a strong rally from mid-May before correcting in the second week of June. Since that time, small caps have steadily gained traction as supportive economic data from the re-opening of the economy has rolled in. Of note, the Russell 2000 (small cap index) still has a good bit of room to run here as the index is still down nearly 12% YTD versus the Russell 1000 (large cap index) , which is nearly even for the year.

Fixed Income

The Fed owns $4.2 trillion of U.S. government debt, roughly 22% of the total outstanding. Since March it has purchased about $1.7 trillion in treasuries with the aim to improve market function primarily focused on the short end of the yield curve. With the short rates anchored near zero, the curve experienced some steepening YTD (2s/10s) of around 45 basis points currently. The yield curve flattened a little in June with COVID-19 cases increasing, but we expect that steepening to continue at a very gradual pace. 

• Real yields remain in negative territory showing the easy monetary conditions
• The Copper/Gold ratio shows rates should be heading higher
• 10-year breakeven has been climbing off the lows of March – a sign that inflation is expected to increase, but still at a low level of only 1.4%

^[1] https://www.statista.com/statistics/242074/percentages-of-us-family-households-with-children-by-type/ 

^[1] https://www.cnbc.com/2020/06/23/65percent-of-colleges-are-preparing-for-in-person-classes-this-fall.html 

^[1] https://www.wsj.com/articles/californias-second-shutdown-11594770566?mod=searchresults&page=1&pos=1 

^[1] Source: Baird-Strategas

^[1] https://www.oberlo.com/blog/small-business-statistics

We begin this newsletter with research conducted by Baird Private Asset Management in response to the recent focus in the media regarding pressure on ICU capacity limits in states that have seen an upsurge in the virus.[1] One fact that has not been widely reported in these stories is that under normal conditions, ICUs at hospitals tend to run at higher levels of capacity, in the range of 55% to 82%. We examined the top 10 states by GDP contribution (cumulatively about 60% of total US GDP), and found that ICUs are actually running within or even below normal ranges.[2] This includes the Sunbelt states, Florida, Texas and California, which have been held out among the leading states experiencing case surges. Remarkably, over the last seven days total estimated ICU admissions have increased by a fractional 635 cases as compared to approximately 375,000 new cases, or 0.17% (Arizona saw a mere increase of 65 cases, and California was actually flat). This compares to peak ICU occupancy due to COVID back on April 17th of 18,000 compared to 6,396 today, when new daily case rates were half of what they are currently.[3]  Equities. With the ongoing rally in stocks, investors continue to question whether current valuations are justified or disconnected from reality. A review of year-to-date industry sector performance suggests that recent valuations remain in-line and fairly priced, and that – with only two of eleven sectors significantly positive for the year – what appears to be disconnected are the indices themselves. Take the S&P 500 index for example, which is now down a mere -2.65% on the year, compared to the underlying sectors that comprise it. This is due to the market-cap weighted structure of this index and many others like it, i.e. larger stocks by market value make up a greater percentage of the index. With the run up in technology stocks, this one sector alone now comprises nearly 30% of the index. The valuations are not at a level that is concerning to us, but the concentration of this sector within the index is at a level we haven’t seen since the “Dot Com” bubble of the late 1990’s.   What this means is that there are segments of the market that remain undervalued and attractive, and there are abundant opportunities in strategies away from the index.

---

^[1] https://www.cnn.com/2020/07/07/health/us-coronavirus-tuesday/index.html

^[2] Source: States’ departments of health

^[3] Source: Institute for Health Metrics and Evaluation

Today we provide a brief update in advance of the Fourth of July holiday weekend, with the markets closed today. The second quarter that ended on Tuesday was the best quarter for the stock market in more than 20 years. This, of course, came on the heels of one of the worst quarters in recent memory, with the stock market falling 35% in less than six weeks due to the shutdown of the global economy at the start of the coronavirus pandemic. The recovery in the markets has been spurred by strong resumption of economic activity combined with unprecedented government stimulus. The S&P 500 finished the second quarter up 20%, its biggest gain since the final quarter of 1998. The rally has cut losses for the year on the S&P 500 and Dow Jones Industrial indexes to -4% and -9.6%, respectively.

The market has looked past the – especially recent – rising number of coronavirus cases considering improving therapies, falling mortality rates and strong prospects for an effective vaccine.  There are over 100 vaccines in development, a handful of which are already at Stage 3 testing. Some lingering concerns remain at the prospect of resumption of shutdown policies in certain hotspots like California and Florida, but for now, the current trend is mitigation through masks and continued social-distancing, with some renewed restrictions on bars and restaurants.  

We had another blow-out jobs number this morning with 4.8 million jobs added in June; well above the 3.7 million anticipated. The unemployment rate now stands at 11.1%. The U.S. had lost more than 22 million jobs at the height of the shutdown in April and has since added back 7.5 million. In addition, new claims for unemployment fell this past week to 430,000; the lowest level since February.  

Investments

While stocks continue to move higher, bond yields remain low and spreads continue to tighten. Credit and municipals have largely recovered from steep losses in Q1. The general tone of the market remains constructive and firm, and demand continues to outstrip supply. The Fed remains a significant portion of that support by purchasing ETFs and individual bonds through its Corporate Credit Facility, which opened on June 29. 

We are also seeing stabilization in the commercial mortgage-backed securities (CMBS) markets after dropping in May. The weakest segments in the BB and BBB- segments have stabilized to some degree over the last few weeks. While we don’t invest directly in the CMBS markets, this is an important indicator for the real estate market. We expect to see a negative Q2 return for real estate; however, most of the impacts have been concentrated in the hotel and retail sectors, where our managers do not heavily invest.  As shown in the table below, these two sectors make up the majority share of CMBS that have transferred into special servicing (i.e., workout, both pre- and post-Covid-19).^[1]

---

^[1] https://www.fitchratings.com/research/structured-finance/coronavirus-pushes-20-billion-of-cmbs-into-special-servicing-17-06-2020