A Smarter Way to Invest Market Summary 7-3-2020

Stock indexes spent the first half of the month continuing to climb before retracting slightly in the second half. On June 8^th, the S&P 500 hit its post-pandemic high of 3,232, enough to turn positive for the year despite negative headlines everywhere you look. At the time, investors seemed optimistic about the prospects of economies around the globe slowly reopening their doors. Just a few days later that optimism came crashing back down to earth with the S&P 500 falling almost 6% on June 11^th. Prices have rebounded since then with the S&P 500 (1.8%), 400 (1.1%), and 600 (3.6%) all gaining for the month as a whole. The Dow Jones Industrial Average climbed 1.7% but the NASDAQ Composite soared above them all with a 6.0% gain. The MSCI EAFE international index rose 3.2% while the MSCI Emerging Market index more than doubled that at 7.0%. The equity sectors were evenly divided with 5 gainers, 5 decliners, and Communication Services essentially breaking even. Technology (6.7%) and Consumer Cyclical (2.8%) led the gainers while Health Care (-2.9%) and Utilities (-5.5%) brought up the rear. Treasuries posted a slight drop (IEF, -0.1%), high yield corporate bonds fell slightly more (HYG, -1.0%), but investment-grade corporate bonds came out well ahead of May (VCIT, 1.7%). Gold (GLD, 2.7%) continued to act as a strong hedge against equity volatility with a steady rise this month, and commodities (DJP, 2.9%) continued to climb out of the pit they have spent most of the year in.

As stocks and economic data continue to rebound (or at least stabilize) the comparisons to the Great Depression have continued¹. The juxtaposition of then and now with regards to unemployment, prices and wages, corporate bankruptcies, government aid, interest rates, and the stock market provides some context for just how bad this first wave of the virus has been and why this event might not be as bad as the 1930s.

In early May, we got our first look at the monthly unemployment picture since the lockdowns. The 14.7% rate at that time was the highest in the post-WWII era² and June’s release was expected to be even worse. Many economists were predicting a figure close to 20% but the actual reading came in at only 13.3%³ causing stock prices to surge with the S&P 500 gaining more than 2.6% for the day. This trend continued with yesterday’s July release showing an unemployment rate at 11.1%. Due to changes in the way data is collected, direct comparisons can’t be made between these data points and those of the Depression era, but estimates for the unemployment rate in the 1930s put the peak somewhere in the 25% range. The current jobs picture is far from ideal, but we’re currently at less than half of Depression levels. Another factor to consider is the length of unemployment. The longer people are out of work, the longer a recovery will normally take. In April, the number of people who had been unemployed for more than six months fell below 1 million, the lowest number since 2001. While that is a lagging statistic, a recent survey also found that 90% of compensation managers still anticipated that virus-related layoffs would be temporary. Those two factors combined provide hope for a strong recovery.

Last month we talked about the drop in consumer prices during April and what problems that could lead to down the road. However, that same reading was stable in May, and by comparison, has barely even budged from recent highs. From the start of the Depression, prices fell 32% due to weak demand while wages fell more than 30% in manufacturing and more than 15% in railroads. As a result, even people lucky enough to remain employed had trouble paying bills. While some industries today have seen temporary wage reductions, others such as grocery stores have seen increases. We are still a far way off from Depression levels here as well.

Corporate bankruptcies are likely to be much higher than during the Depression but much of that has to do with changes in the law and the stigma attached to filing for bankruptcy in the 1930s. Today, laws allow companies to reorganize in bankruptcy instead of liquidating in order to minimize the economic impact of a company going under. 28 companies sought bankruptcy protection in May raising the total to 99 so far this year, well ahead of 2008’s pace.

Government aid was non-existent prior to the Great Depression. Wisconsin became the first state to create an unemployment insurance system in 1932, Social Security wasn’t enacted until 1935, and the U.S. government ran a budget SURPLUS in 1930 while the 1931 deficit was only 0.5% of GDP. After multiple rounds of stimulus this year, the U.S. budget deficit is projected to reach 9% of GDP. Government aid made up one-third of personal income in April, up from 19% pre- lockdown, and of the people who have filed for unemployment benefits, half are estimated to be making more than they were when fully employed.

The interest rate environment right now could not be more different than during the Depression. In order to reduce speculation in the surging stock market of the 1920s, the Federal Reserve raised interest rates as a way to incentivize individuals to save money in safer options at banks. As a result, the stock market collapsed, and in 1932, the Fed actually raised rates again to protect the value of the Dollar. All of this was happening as prices and wages collapsed, meaning that real rates (nominal rates minus inflation) reached a high of around 15%. The real rate in April 2020 was just above 0.5%, much more accommodating for an economic recovery.

Finally, stock prices. While the speed of the 2020 crash was unparalleled, it only dropped 34% from February’s high to March’s low. Conversely, the predecessor of the S&P 500 fell 86% from peak to trough after multiple sell-offs during the Depression. Furthermore, as of the June 30^th close, the S&P 500 was only down 8.4% from its February 19^th peak. With everything going on not only related to the virus but now the protests occurring around the world, why are stocks still seemingly unfazed?

Some factors have already been discussed here and the surprise jobs report in June also provided some fuel but in reality, many investors are physically and emotionally disconnected from what they see on the news. Only half of Americans reported having retirement savings accounts in the Fed’s 2016 Survey of Consumer Finances⁴. That figure was even lower among Hispanic and black respondents⁵. The economic toll of the pandemic has hit different socio-economic cohorts to very different degrees. With that in mind, it is much easier to understand a narrative where the terrible economic data we have seen disproportionately reflects the situation of lower-income Americans who are less likely to own stocks, while higher-income Americans who are more likely to own stocks have been less impacted and continued to buy or at least hold on to their equity positions.

For those who do own equities, memories of the post-2008 rally and the rebound from Christmas 2018 are fresh and people don’t want to miss out⁶. Retail investors have been trained to stay the course and not panic in light of short-term drops. Others, aided by trading apps like Robinhood, have started a resurgence in retail speculation as some of the names hardest hit by the pandemic have seen the largest spikes in trading volume. A recent survey of Vanguard clients found that overall, short-term expectations about the market and economy became more pessimistic after the crash, but long- term expectations were unchanged and remained positive.

With those long-term attitudes increasingly cemented and stocks having largely regained their losses from earlier in the year, there is a sense of complacency among policymakers⁷. A large factor behind the second-quarter rally was government stimulus and actions taken by the Federal Reserve. As equities continue to climb, there is less of a sense of urgency for future action. Talks for another round of stimulus continue in Congress but the amount being discussed is already lower than what was being floated just a month ago. The Fed seems to have put a floor in place for equities based on its actions in March, but many seem to think that future aid will still be needed as the pandemic drags on beyond the summer. The boost to unemployment that the Cares Act provided will expire at the end of July. That may give us our first glimpse of how the economy, stock market, and policymakers subsequently respond.

Adam Blocki, CFA, CFP®

Sr. Portfolio Manager