A New Normal
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After a dismal first quarter for global stock markets, the second quarter was a welcome reprieve. Equity markets staged a fierce rally during the second quarter as investors bet on a quick resolution to the Covid-19 pandemic. However, stocks returned to selling pressure the past two weeks as cases have begun to spike across the U.S., leading to fears that the economic recovery will not be as smooth as many hoped. The unpredictable nature of Covid-19 makes forecasting very difficult and it is likely that a true recovery will not be seen until a vaccine is readily available. When the economy does recover, many industries will be forever changed and will be faced with a new normal.
Pandemic
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Since our last letter to you at the end of December, the world has changed with breathtaking speed. As the COVID-19 pandemic has raced around the world, economies have ground to a halt, equities markets have plunged, lockdowns have become the new normal, and everyone’s lives have changed dramatically. From our perspective as money managers, you really could not imagine a more disruptive event. When we experience disruptive events like this, we always look for similar events in the past to get an idea of what it might look like. For this pandemic, there are really no parallels. We have basically shut down our economy for a sustained period of time. That’s never been done before. Adding to the economic shock is the collapse in oil prices, which, if not for the pandemic, would be the major news event so far in 2020. We normally do not like words such as “Plummet”, “Plunge”, and “Crash”, but all three seem appropriate for describing the markets and the economy this quarter.
2019 Year End Review
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After a difficult year in 2018 for both stocks and bonds, the U.S. capital markets roared back in 2019 with strong gains across the board. The bond market posted gains as interest rates dropped throughout the year. Stock indices in the U.S. are near record territory, recovering from last year’s losses and extending the bull market run that started in 2009.
The Economy and The Fed
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The stock market continued its volatile ways during the second quarter, finishing with small gains for the quarter. The bond market had a strong quarter as interest rates fell in response to slowing economic growth. It is also notable that the Federal Reserve cut the Fed Funds Rate during the third quarter for the first time in more than a decade. The U.S. economy is being impacted by slowing global growth and domestic trade policy.
Roller Coaster Stocks
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After a strong first quarter, global stock markets gave us increased volatility during the second quarter before finishing the quarter with solid gains. Stocks were strong in April, suffered a large sell off in May, and rebounded once again in June. Bonds were much more stable, following up a good first quarter with more gains during the second quarter. Mixed economic data and heightened trade fears left investors unsure of where the economy is headed, which increased volatility.
2018 Year End Review
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It was difficult to make money in 2018. The equity markets experienced their worst year since 2008, and had their worst December performance since 1931, despite a furious rally the last week. The bond market, facing rising interest rates all year, was negative most of the year until a December rally left it even for the year. Global stocks fared worse that U.S. stocks as questions about world wide economic growth rates hung over markets around the world.
Historic Bull; Missing Bear
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During the third quarter, the current bull market in U.S. stocks became the longest running bull market in our history. Beginning on April 10th of 2009, the S&P 500 has gained 430%. During that time, it has also experienced eleven drops of at least 5%, and five corrections of at least 10%. Bull markets end with a drop of at least 20%, when we enter bear market territory. This has been a very resilient bull. Meanwhile, in the bond market, rising interest rates have led to falling bond prices throughout the year.
Head Winds
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For the capital markets, the second quarter of this year was very much like the first quarter. Equity markets were volatile and ended up close to where they started, at least on the domestic side. Bonds continued to struggle as interest rates moved higher. Global stocks and emerging market stocks sold off as worries rose about the state of the global economy. In the U.S., fears of higher inflation combined with worries over free trade, causing investors to fear that the nine-year economic expansion may be in danger. The yield curve has become very flat, meaning there is not much different between short term and long term interest rates. This is rarely a good sign for the markets.For the capital markets, the second quarter of this year was very much like the first quarter. Equity markets were volatile and ended up close to where they started, at least on the domestic side. Bonds continued to struggle as interest rates moved higher. Global stocks and emerging market stocks sold off as worries rose about the state of the global economy. In the U.S., fears of higher inflation combined with worries over free trade, causing investors to fear that the nine-year economic expansion may be in danger. The yield curve has become very flat, meaning there is not much different between short term and long term interest rates. This is rarely a good sign for the markets.
Choppy Markets
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The first three months of 2018 were very entertaining if you like market volatility and drama. January started the year off strong as we saw equity market gains across the board. February and March were both negative months with markets experiencing greatly increased volatility, including two trading days in which the Dow Industrials lost over one thousand points. Higher interest rates and increased fears of inflation caused the bond market to also drop during the first quarter. This was one of those quarters where gains were hard to come by regardless of how you were invested.
The current bull market began nine years ago during the Great Recession of 2008-2009. During this nine-year run, the equity market has had a few corrections, defined by a 10% drop. In February the market dropped 10% from its January highs, rallied, and then fell to the 10% level once again. In times like these the question is always, “Is this a temporary pull back and thus a buying opportunity?” or “Is this the early stages of a deeper sell off and thus a chance to sell?” We believe the answer depends on your time horizon. The stock market is highly priced right now and a deeper sell off would not be surprising. However, we also feel that we remain in the midst of a longer-term secular bull market that has more time to run.
2017 Year End Review
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Another year in the books. 2017 ended with strong equity markets as the eight-year bull market continued to impress. Global stocks did especially well as economic conditions improved around the world. The bond market produced small gains, as it has for the past few years, as the prospect for rising interest rates kept gains in check. The equity markets experienced relatively low volatility, with the best one day gain for stocks during the year being 1.4% back in March, while the worst one day drop was a loss of 1.8% back in May.
We pointed out a year ago that the current economic expansion is one of the longest expansions since World War II. A year later nothing has changed. Economic growth has continued as has new job creation. Corporate earnings remain strong and most measures of economic activity continue to look good. Based on the economic data we are seeing, an economic recession seems unlikely in the upcoming year.
