Published on May 12, 2020
April 2020 | Equity Commentary
Stocks rebounded in April as the S&P 500 gained over 12.5%, marking its best month since January 1987. Investors looked past dismal economic data and instead focused on the potential for improving conditions as many states took initial steps to reopen their economies and progress appears to have been made with regard to a potential coronavirus treatment. Additional rounds of fiscal and monetary stimulus also look to have buoyed investor spirits.
The US government and Federal Reserve continued to expand their various initiatives to support the economy over the last several weeks. The Federal Reserve announced that it would provide up to an additional $2.3 trillion in credit to businesses and state and local governments. This includes $600 billion for its Main Street Lending Program whereby the Federal Reserve will partner with commercial banks to provide loans to small and mid- sized businesses. In addition, Congress authorized an incremental $484 billion in fiscal stimulus, the majority of which will be allocated to its own small business lending program, which had already exhausted its initial $350 billion in funding.
There have been challenges associated with the rollout of these various programs. This is not surprising to us given the speed with which they have been implemented. Examples include certain publicly traded and/or higher profile companies which were able to access funds that were intended for smaller businesses. In our view, speed was of the essence here. The government and Federal Reserve had to act quickly in order to stave off a potential economic calamity, and we view the trade-off of a faster, yet imperfect rollout as being acceptable, all things considered. A bigger concern is that more will likely be needed in order to support states and local governments. Given the requirement that states maintain balanced budgets, massive cutbacks will likely be in store if the Federal government does not provide more financial assistance. While we understand that each additional round of government stimulus becomes more politically challenging to implement, we think the alternative of forcing states and local governments to slash budgets would be a mistake, and counterproductive towards the goal of supporting economic activity.
Economic data released during the month was, as expected, weak. Many key economic indicators experienced their largest ever recorded monthly declines, including consumer and small business confidence, and retail sales. Aggregate jobless claims spiked to an unprecedented 30 million over the six weeks ending April 25th. As a point of comparison, the four-week moving average of unemployment claims through the 1st week of March was approximately 220,000. While there were few silver linings to be found among April’s data releases, judging by the financial market’s performance during the month, investors were clearly able to look past these numbers. We believe that this was in part a function of very low expectations given that so many businesses have been forced to at least temporarily shut down or operate at reduced capacity to help slow the spread of Covid-19. Moreover, with many states having already begun to take initial steps towards reopening their economies, we believe that investors are optimistic that business activity will rebound materially over the back half of the year.
We believe the path ahead for capital markets and the economy will likely hinge on the extent to which the coronavirus continues to spread. New case numbers in many parts of the country have started to trend favorably, which gives us reason for optimism that the worst of the economic damage may already be behind us. Moreover, there has been some progress made with regard to potential coronavirus treatments and vaccines, and the FDA has been proactive in removing hurdles which would otherwise slow the potential time to market for such therapies. We are also seeing inflections in financial market indicators which suggest that the investment climate may be improving. In addition to the equity market’s strength last month, other risk metrics such as credit spreads and the volatility index have improved considerably. Finally, we note that China’s economy has begun to rebound, which should have positive implications for the US multinational corporations that do business there.
We believe a bear case would likely be a function of a resurgence of the virus, either due to states allowing businesses to reopen prematurely, or as some experts have predicted, from another wave of infections that may ensue during the fall. Under this scenario, economic activity would likely be impacted for longer than investors currently expect, and stocks could be at risk for further declines. Moreover, the material uptick in unemployment could negatively impact consumption for a prolonged period, igniting a vicious cycle whereby businesses see further declines in revenues, necessitating additional rounds of job cuts. While we would ascribe a higher probability to the upside case, we think the potential for further market declines is plausible enough to warrant a barbell approach to portfolio construction. In this regard, we have been adding to stocks that we expect would outperform in upward trending markets, but we continue to maintain sizeable allocations to more stable and defensive holdings that we believe would help to preserve capital should market conditions deteriorate.