What’s next after market surge?
Due largely to unprecedented government stimulus programmes, global markets recovered strongly in the second quarter. The S&P 500 gained 20.54 per cent while the MSCI World Index recovered 19.57 per cent, marking the best quarterly performance is 1998. Initial gains in the consumer staples and healthcare sectors were followed by a recovery in consumer discretionary stocks. Meanwhile, information technology remained a bright spot as the Nasdaq touched a new all-time high.
In terms of the real economy, the past few month's rebound from March's lows has been almost as dramatic as its sharp deterioration in the first quarter. The widely followed purchasing manager index (PMI) has shown recent strength in both manufacturing and services on a forward-looking basis. In June, the manufacturing PMI increased by 22 per cent to 52.6 from 43.1 in the prior month after tumbling by over 18 per cent from February to April. Similarly, US single family home sales increased by 16.5 per cent from April to May, although sales remain below levels seen at the beginning of the year. And finally, retail sales bounced back by a whopping 17.7 per cent in May after plunging over 22 per cent in the prior two months.
In the fixed-income markets, corporate and municipal bond spreads continued to tighten in the second quarter after the Federal Reserve announced its Emergency Lending Programme in late March. The spread between BBB-rated bonds and the ten-year US Treasury yield has narrowed by more than 1 per cent to 1.73 per cent as of the end of June. The mere announcement of the Fed's programme boosted investor confidence.
Most of the $2.6 trillion available through the Fed's eleven emergency facilities remain untapped as many local governments and businesses were able to secure financing through the debt market.
The Treasury yield curve steepened slightly over the quarter with medium term yields moving lower while long-term yields modestly increased. Central banks around the world have shown commitments to “whatever-it-takes” approaches to support their economies. In the US, Fed chairman Jerome Powell has indicated the policyholders' plan to maintain the target rate at zero until the economy fully recovers.
Progress has also been made on the employment front, albeit at a slower pace. The post-Second World War record unemployment rate of just 3.53 per cent suddenly spiked to a new high of 14.7 per cent for June — over four per cent higher than the level experienced during the depths of the 2008 Great Recession. At the same time, continuing claims for American unemployment insurance reached an all-time record of 24.9 million in May. However, that number has been gradually improving as the economy slowly reopens.
In the equity markets, leadership has been maintained by the so-called “stay-at-home” stocks such as Amazon, Facebook, Netflix, Microsoft and Apple. These technology-enabled stalwarts continue to benefit from ongoing government-restricted movement and the ubiquitous fear of straying too far from home. While the flight to disruptive players may seem fresh, the pandemic is really just accelerating secular trends already in place. For example, the shifts towards cloud-based computing and widespread e-commerce adoption had been under way for some time. Other beneficiaries of restricted movement include grocery stores, consumer staples companies and electric utilities with high exposure to residential customers.
Going forward, many of these defensive growth stocks are likely to retain their lustre while continuing to command premium valuations. However, as the economic recovery takes hold, investors need to consider other more reasonably priced issues which have been left behind in this past quarter's risk market resurgence. Specifically, individual securities in the industrial, telecommunications and healthcare industries look attractive going into the second half of 2020.
Healthcare, for example, stands to benefit from the trend towards ageing developed world populations in the intermediate term and a reopening of healthcare facilities in the near term. Many elective procedures in hospitals have been deferred while staff focused on Covid-19 containment. Furthermore, several world class pharmaceutical and biotechnology companies are participating a heated race to build effective vaccines and therapeutics to deal with the disease.
On the vaccine front, more than 100 projects around the world are in development and at least eight candidates are already being tested in humans. The next step involves larger scale testing which should begin this month. Biotech firm, Moderna is expected to start a 30,000 patient trial this month. Meanwhile, both Pfizer, joining forces with a smaller company, BioNTech and AstraZeneca, working with Oxford University are also moving into similarly sized Phase 3 clinical trials. Initial results are expected to may be seen as early as September.
Based on historical success rates, there is a good chance we see a vaccine approved in the first quarter of next year, or possibly even before the end of this year. Following approval, the challenge would then shift to distribution of the product and determining whether permanent immunity can be conferred.
Of course, the successful development and distribution of a vaccine, or if the virus dies out on its own, this would be quite the panacea for many still beleaguered areas of the market.
• Bryan Dooley, CFA, is the senior portfolio manager and general manager of LOM Asset Management Ltd in Bermuda. Please contact LOM at 292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.