Quarterly Market Review and Outlook
2020 Q2 Financial Market Re-Cap
In the immediate aftermath of the 1st Quarter market crash, many “experts” overtly debated the probability of a market rebound as well as its shape. We all heard various prognosticators issue projections of a potential stock market recovery resembling all sorts of letters: L, W, V, and U. Currently, the small number that argued for a V-shaped market rebound seem to be the smart ones—at least in the moment. If anything, the 2nd Quarter reaffirmed our long-stated philosophy that trying to guess on upcoming market direction on a daily basis is a fool’s errand.
Through the first half of 2020, the U.S. stock market (as measured by the S&P 500) is down approximately 5%.i Foreign markets continued to trail their U.S. counterparts and are down for the year by roughly 11%.ii U.S. stocks outperforming International stocks has been a trend for over 10 years now—we don’t see that changing anytime soon.
With unprecedented backing from the Federal Reserve, the U.S. fixed income market has stabilized from the volatility in the 1st Quarter and is up 6% for the year.iii As with the stock market, U.S. bonds generally outperformed their foreign counterparts.iv
While some degree of calm has returned to financial markets, we would caution against assuming that all is clear in the short term. There are plenty of potential hurdles to clear that need to be prudently and skillfully navigated as we get into the second half of the year. The first half has been quite a journey—we are hoping for the best but preparing for the worst! The bottom line is we are not completely out of the woods yet, but we are not too anxious about what lies ahead either.
2020 Q3-Q4 Outlook
COVID-19 Economic Update
COVID-19 continues to remain near the top of most news headlines as it pertains to the economy. Much of the 2nd Quarter’s discussions have centered on federal, state, and local governments attempts to reopen the U.S. economy in stages. There are medical, political, and economic impacts of the COVID crisis—we will stick to writing only about the economic implications.
Approximately 65% of the U.S. economy is based upon consumer spending. On June 25, 2020, the Bureau of Economic Analysis (BEA) issued their third estimate of 1st Quarter 2020 U.S. GDP—it showed that the U.S. economy contracted by an annual rate of 5.0% (-5.0%).v The Atlanta Federal Reserve’s GDPNow model currently projects that the U.S. economy contracted at an annualized rate of 39.5% (-39.5%) in the 2nd Quarter.vi The BEA will release the initial estimate for Q2 on July 30th.vii These are Great Depression-type numbers! When the consumer does not spend, the economy tanks.
We tend to believe that economic recovery is well underway and only another round of business closings would derail that. The media seems to say that we are in the middle of a new and concerning outbreak of
positive cases. It seems like to us that more people are testing positive because many more people are getting tested. It also appears that the ICU capacity in the U.S. is not being taxed and the death rate has not gone up viii. For all those reasons, we do not see another round of closings coming.
We are very thankful that we did not have to make the difficult decisions on how and when to reopen the economy. We hope that those individuals that are making decisions look at all parts of the equation, have a great amount of wisdom, and put partisan politics aside—the repercussions of a faulty decision have the potential for long-term impacts.
Federal Reserve Action
We do not subscribe to the notion that the Federal Reserve by itself creates jobs, grows the economy, or pushes the stock market to new heights. However, it would be foolish to think that they do not have a very real and critical role to play. In our opinion, the important role they play is to instill a degree of confidence in the economy. People are less likely to take risk if they perceive that the pain significantly outweighs the reward. The Fed tends to serve as a backstop to the economy.
In an effort to bolster investor psychology and confidence, the Federal Reserve has taken unprecedented and extraordinary measures in the 2nd quarter. In summary they cut interest rates to 0%, initiated a bond buy-back program, and brought quantitative easing back to the stock market. We believe Fed action is the specific reason that the stock market staged its dramatic recovery and the bond market returned to normal operation in the 2nd quarter.
Additionally, during the press conference for the June 2020 Federal Reserve meeting, Chairman Powell stated he anticipates interest rates to remain at their current levels for “the next couple of years.”ix The economy likes low interest rates—the fact that he said they would remain that low for so long should be very comforting to investors.
There is an old Wall Street saying, “Don’t fight the Fed.” We tend to agree and we are not.
2020 Election Cycle
In case you forgot, there is a Presidential election in November! We have fielded many questions about the impact of the 2020 election. Again, other than stating that the presidential election will likely be determined by a handful of states, we will stick primarily to an economic and market analysis.
We think the Founding Fathers who wrote the Constitution were very smart. They intended for it to be hard to get significant things done in our system of government. For that reason, unless one party controls both the White House and Congress, the result should the same as the last several years—gridlock. In the past, the financial markets have liked gridlock. We think it may be hard for either party to win both branches of government in November.
With that being said, a Joe Biden victory and a sweep of both Houses of Congress by Democrats could put the Tax Cuts and Jobs Act of 2017 (i.e., Trump Tax Cuts) on the table for repeal or adjustments.x In other words, they would raise taxes. Biden has said that very clearly. Raising individual or corporate taxes tends to drag the economy. As the economy continues to crawl out of recession in 2021, a tax increase, in our view, would be a bad idea.
A Trump and Republican sweep should produce potentially more tax cuts. The economy was extraordinarily strong going into the current COVID induced recession. We believe that happened in large part because of the 2017 tax cuts. Trump has been a catalyst in reducing the regulatory burden that companies face—we would expect that to continue if he is reelected.
Another potential item to watch is the ongoing trade deal negotiations with China. China is truly our enemy—clearly from an economic perspective but also in their lack of transparency in how they handled COVID. We do tend to forget that the Chinese are communist. Since Trump took office, we generally have been much tougher on them and have negotiated for a deal that was fairer to the U.S. A Biden Presidency would likely return to a policy of appeasement that we have been pursuing since the first Bush term. We think this is a critical issue that does not get enough serious coverage from the media.
We think this election is terribly important for many reasons. However, the stock market has advanced and declined during both Republican and Democrat controlled periods. We think it unlikely that either party will run the table in November. We also think it unlikely that the election results, whatever they are, will cause an immediate stock market crash or a new bull market.
First, between the coverage of the COVID recession and the recent rash of protest induced rioting and looting, we are reminded that the media is terrible and corrupt. At a time when there are many ways to get information, we would contend that wisdom is in short supply. Our advice is to be incredibly careful about where you place your faith and confidence in when it comes to the media. We have our trusted and reliable sources for economic, financial, and market news and information—we feel particularly good about that.
Second, we recommend against making rash and emotionally influenced investment decisions. Financial markets have been volatile in 2020. For all that we have experienced though, the stock market is only down a few percentage points this year. The bond market is up. We think it is prudent, outside of a strategic holding of cash, to remain fully invested. It depends from client to client, but a 10% to 20% cash cushion can provide protection and dry powder when an opportunity presents itself.
Third, we think it’s important to periodically reassess financial and economic goals. If you have any life or economic changes that we need to discuss, please do not be shy in reaching out to us. We want to assist you in accomplishing your goals. That is the standard in which we hold ourselves.
Finally, and most importantly, keep hold of that which you hold most dear. Don’t get beaten down by the chaos occurring in the World. There has always been chaos and there will always be chaos. Focus on what gives you happiness—family, God, work, and your friends deserve the bulk of your attention.
We wish you, your family and friends much health and happiness during the Summer of 2020!
x Breuninger, Kevin. “Biden Tells Donors: I’m Going to Get Rid of Most of Trump’s Tax Cuts and ‘A Lot of You May Not Like That”. June 29, 2020. CNBC.Com. www.cnbc.com/2020/06/29/biden-tells-donors-he-will-end-most-of-trumps-tax-cuts.html
Securities offered through First Heartland Capital ®, Inc., member FINRA/SIPC. Advisory Services offered through First Heartland ® Consultants, Inc. Walker, Higgins & Associates, LLC and Walker, Higgins & Associates Wealth Management, LLC are independent of First Heartland Capital ®, Inc. and First Heartland ® Consultants, Inc.