When we wrote our previous market commentary back in March, we were hopeful that the financial markets would quickly recover from the exogenous shock of COVID-19. Broadly speaking, US stock and bond markets have largely recovered. At this juncture, though, many are questioning the sustainability of the recovery in financial markets absent a full economic reopening.
Our elected officials have the very difficult task of balancing public safety with reopening the economy. Unfortunately, many of the states that reopened the earliest have reversed course in response to spikes in new COVID-19 cases. Texas is one of those.
Spikes in new cases have resulted in declines in business activity. Temporary business closures are becoming permanent, especially in the restaurant and retail sectors. Small business hiring data has steadily declined since April. Last week, for the first time since March, there was a reported rise in initial jobless claims nationwide.
The federal government, through Congress, has already doled out massive amounts of fiscal stimulus under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. (As an aside, the US ran an $864 billion federal budget deficit for the month of June, compared to a $984 billion deficit for the entire 2019 fiscal year!)
Some of these measures are now expiring. Last Friday, the renters’ eviction moratorium, which covers federally-financed properties, expired. This week, the $600/week in federal unemployment assistance is set to expire.
There is a furious, worldwide race for a COVID-19 vaccine. According to the Milken Institute, there are currently 199 vaccines in the developmental stage! In May, the Trump administration initiated “Operation Warp Speed,” an ambitious effort to accelerate the development and production of COVID-19 vaccines through public-private partnerships.
The federal government has invested billions in vaccine candidates from Johnson & Johnson, Moderna, AstraZeneca, and others. Last week it was reported that the US will pay Pfizer and biotech firm BioNTech $1.95bn for 100 million doses of the COVID-19 vaccine, with an option to acquire an additional 500 million doses, if proven safe and efficacious in a large Phase III clinical trial.
As you can see from the chart below, the traditional vaccine development pathway takes between 6-20 years from initial discovery and target validation to final regulatory approval of a new drug.
Source: The New England Journal of Medicine
The timeline up to Phase I for a COVID-19 vaccine has been six months! Just this week, Moderna announced it had launched Phase III clinical trials and is anticipating enrolling 30,000 US participants. Further, in an unprecedented manner, drug companies are making commercial scale vaccines and ramping up manufacturing capacity prior to regulatory approval. The full cycle for a COVID-19 vaccine could be as short as 9-18 months.
The US stock market, as represented by the S&P 500 Index, bottomed out on March 23rd and has since recovered its losses – flat on the year. The tech-heavy Nasdaq 100 Index, on the other hand, is up over 22% year-to-date!
Almost half of the value of the Nasdaq 100 is concentrated in just five names: Apple, Microsoft, Amazon, Facebook, and Alphabet (both share classes). Each of these have delivered strong year-to-date performances: AAPL +29%; MSFT +29%; AMZN +65%; FB +14%; GOOG/GOOGL +14%. These same names are driving the performance of the S&P 500. (Excluding these names, the S&P 500 would be significantly negative year-to-date.)
Large-capitalization tech companies have also delivered on a relative basis…relative to everything else. The relative outperformance of the sector and the growth style category, in general, has led some to decry the death of the value style category of stocks. After all, who wants to own a boring, old-economy bank or manufacturer, right?
As Mark Twain famously said, “History doesn’t repeat, but it often rhymes.”
We’ve heard this before – remember the Tech Bubble”? This is the cover of Time Magazine from September 27th, 1999. Six months later the bubble had burst, and the Nasdaq Composite Index eventually gave up nearly all of its gains from the previous five years.
Today, as back then, there is a large performance divergence between the best and worst performing industries, and between growth and value stocks. Similarly, there is a strong sense of (irrational) exuberance surrounding the stocks of top performers. Tesla, anyone?!
But it defies conventional wisdom that during this pandemic the riskiest and most expensive (high P/E) stocks have handily outperformed those stocks deemed safe and inexpensive by most traditional measures. What’s going on?
One reason why growth has outperformed value is the low-interest-rate environment. Interest rates were cut in response to a weakening economic outlook, which is a negative for economically-sensitive companies. (These are called “cyclicals.”) Also, low interest (discount) rates render the higher cash flows from value stocks less valuable when discounted to the present. Another factor driving “sexy” growth stocks is margin – low borrowing costs incentivize levered speculation.
Thanks in large part to monetary policy actions by the US Federal Reserve bond yields are at their lowest levels in history. Currently, US Treasury bond yields range from 0.1% for a 3-mos T-bill to 1.2% for a 30-year T-bond! Yields on investment-grade corporate bonds have fallen commensurately.
More Quantitative Easing from the Fed is likely forthcoming; however, any additional monetary policy measures would expectedly offer diminishing marginal returns. We suppose the Fed could take interest rates into negative territory – not beyond the realm of possibilities.
In our view this is a treacherous environment for bond investors. There is simply not enough yield to be made in high-quality government and corporate bonds. Locking in yields at these levels will almost certainly guarantee a negative return, at least on a real basis (net of inflation). Financial planners and asset allocators need to revisit their long-standing assumption of 5%/yr nominal (pre-inflation) returns on high-quality bonds.
It is noteworthy that precious metals have been on a roll. Gold, for example, is up over 30% year-to-date and trading near record price levels. Low interest rates have certainly played a role, making non-interest-paying precious metals more attractive relative to yield-bearing assets. We believe that gold has been the primary beneficiary of the “fear trade” resulting from the pandemic and weakening global economy, and diminishing confidence in global central banks.
We intend to write more on this subject in the future, especially in the context of alternatives to traditional fixed-income.
Presidential Election Year
Every presidential election we’re told, “this is the most important election in our lifetime.” This one is no exception. What does seem different this election cycle is the all-out “weaponization” of news and financial and economic data. One of the most important factors for an incumbent president is the state of the economy. Therein lies the problem: partisans on both sides know this all too well.