2020 is a year that will change our path forward in many areas of our lives. From science and healthcare, to travel and spending habits, to social interactions and educational and business operations, we will have to continue to adapt and work toward efficient systems that create safe environments in our communities. This is also an election year, so we face decisions that impact policy in the years to come. As we approach mid-year in a year that feels like a whirlwind, let’s examine some key information that has an effect on our investment experience.
Economic Growth
The first six months of 2020 have placed us solidly in a recession. With the forced shutdown of economic activity late in the first quarter, the goal over the last three months was to re-open in a way that will get us back on track safely. This is still a work in progress.
Both the Chairman of the Federal Reserve and economists of the International Monetary Fund have cautioned that economic growth will be challenged and disrupted and that we should not expect a fast V-shaped economic recovery. This makes sense; however, it is difficult to really know what negative recessionary effects will be long-lasting and which will not.
In our current situation, government stimulus and action seem to have provided some stability. Personal income and savings increased this quarter which is largely due to stimulus checks and increased unemployment benefits.
These actions translated to positive signs of life for our economy. In May, retail sales bounced back with almost an 18% increase. However, to put this in context, retail sales were still down about 6% from the previous year which means that when you combine that with an expectation for sales to grow, There was about a 10% decline from normal expectations. Still, the rebound trend was a positive sign.
The question now is: What happens next? Since government stimulus is short-term, Will we see the negative consequences of a recession have a delayed effect on the consumer? The answer really depends on how we approach the Covid-19 situation.
Covid-19 and Re-opening
If you are confused about how to proceed with social interactions right now, you are not alone. People seem to be becoming increasingly frustrated with limitations on activity and safety precautions have become somewhat politicized. I laughed the other day as I finished my grocery shopping while wearing my required protective mask only to see that the fitness bootcamp studio next to the grocery store was packed to capacity with their patrons unmasked. It is no wonder, why there is some confusion right now.
With re-opening being controlled on a state level, many states have rushed to lift restrictions before meeting CDC guidelines. As a result, seventeen states have reported record daily numbers of confirmed infections in the last week. This is not only alarming for the health and safety of our communities, but also for our economy.
As far as an economic and business perspective, there has been some disconnect between the private sector’s desire to re-open and public health experts. While public health experts have been warning that if economic restrictions are lifted too early there may be a second wave of infections, many have celebrated the lifting of restrictions and are looking forward to a spike in economic activity. Many feel that even if there is a second wave of spikes in infection rates, if there are not more shutdowns, the economy will continue to get back on track. However, research shows that in the 1918 pandemic, US cities that lifted restrictions had a larger outbreak and slower economic recovery. This presents a tough situation. Even without forced lock-downs, further outbreaks could cause consumers to retreat on their own and a successful economic recovery could be prolonged.
This type of uncertainty has caused some recent fluctuations in the markets as investors seek to understand how companies will continue to be affected.
Market Valuations
Most of us see daily headlines regarding “the market.” In general, the headlines often refer to the “the market” as a major index, most commonly the S&P 500 (the largest 500 US stocks by value). With the headlines constantly changing, it is difficult to know where we really stand.
Overall, it has been quite the year. With a drop of over 30% in March, followed by an extreme re-tracing so that now the S&P 500 sits just down almost 7% for the year. This path of recovery has pointed to expectations that companies will return to normal and corporate revenues will be strong in the coming years.
When markets are such a roller-coaster ride, it naturally leads people to be cautious and distrust the values. Questions that I often hear right now is: Has the market recovered too quickly? Are we overvalued? While there may be some risk that there is some overvaluation in the market, it is extremely unlikely that we will touch back down to the lows that we saw earlier this year.
A closer look will show that we still have a lot of room to grow from here and that there is opportunity if we have a safe approach to recovering from the pandemic.
Opportunity
As I mentioned before, when you read about “the market” you are often reading about the S&P 500. However, the S&P 500 is not necessarily a great indicator of the entire market. The S&P 500 is a value-weighted index, which means that companies with larger valuations will make up a larger proportion of the index than smaller ones. The top 5 stocks in the S&P 500 are Microsoft, Apple, Amazon, Facebook, and Alphabet (Google). These companies have a huge impact on the value of the index. They are so large that they make up the same value as the next 24 stocks combined! To put that in perspective, the next 24 stocks include huge companies like Johnson & Johnson, Walmart, Coca-Cola, and Exxon to name a few. What I am saying is that a huge factor in the performance of the S&P 500 recently has been the performance of large technology companies that have not had as much sensitivity to the Covid-19 crisis.
This means that there are still industries and sectors that are presenting low valuations and high future growth opportunities as our economy continues to recover. Another indicator of opportunity is a look at the Russell 2000 index. This index measures the performance of the smallest companies in the entire market. Since this index is a measure of smaller business it tends to be a good reflection of the actual experience of local and regional companies. This index is still down 17% for the year.
Moving Forward
The bottom line is we still have some work to do. A well-diversified investment portfolio should be exposed to the positive performance that the large technology companies have given us over the last few months, while also providing exposure to the opportunity that lies ahead in economically sensitive and smaller companies.
At Centered Financial, we continue to implement a barbell approach which provides weight toward stability and growth for the current environment and exposure to long-term investments that show a promising future as the economy recovers.
A strong economic recovery will most likely depend on a cautious resilience. We will need to support our local businesses by being smart and pro-active as a country but do it in a way that is safe and considerate of others.