Second Quarter 2020 Market Recap
A Disconnect between Main Street and Wall Street
It wasn’t that long ago, one quarter in fact, when concerns about the coronavirus and the disruptions it might cause triggered a 34% peak to trough decline in the S&P 500 Index. Those concerns became reality in the second quarter as the Atlanta Fed forecasted an annualized quarterly real GDP growth of -35.5% and the number of unemployed jumped to 17.8 million. Yet stocks have staged an historic rally. The Dow enjoyed its best quarter since 1987 (+17.8%), while the tech heavy NASDAQ returned +30.6%, its best quarter since 2001. The big question on investors’ minds is what can explain the market rally when lives and livelihoods remain disrupted, and the path of the economy’s reopening remains murky. We offer several explanations for this apparent disconnect between Main Street and Wall Street below.
It’s an Illusion: The financial economy and the real economy aren’t as unlinked as certain stock indices suggest. Rather, a handful of mega-cap stocks (such as Amazon, Netflix, Microsoft and Apple, which are up +56.4%, +47.4%, +30.8% and +24.0%, respectively, in the first half) were able to benefit from the environment. However, when one looks beyond those names, the equally-weighted S&P 500 returned -11.7%; and Mid Caps (-13.7%), Small Caps (-14.1%), and International (-10.2%) stocks all posted double-digit losses as well. Most stocks reflect common perceptions about the real economy and certain sectors like travel have been pummeled.
The Federal Reserve: The Federal Reserve has pulled out all of the stops to prevent something bad from turning into something catastrophic. Their response this time around has been faster and more extensive than anything in history. In fact, the coronavirus has accelerated a new paradigm of coordinated monetary and fiscal policy in which central banks are printing money to finance large deficits and spark spending. In the end, the Fed’s actions will promote recoveries on both Wall Street and Main Street…the trading of electronic securities just happens a lot more quickly than the flow of goods and services.
Corporations Reacted Swiftly: When faced with 2020 revenue declines of $4.8 trillion, corporations acted quickly to cut expenses including payrolls and expenditures on intermediate goods. While investors applauded these short-term measures to preserve profits and mitigate losses, these actions shifted the burden to Main Street. The question now is whether belt tightening and lower incomes on Main Street will impact corporate profits.
Where does this leave us? The market’s reaction to the pandemic is perhaps not as distorted as it appears, but we can’t ignore a decade plus of exceptional returns driven by interest rate and tax rate reductions that have their natural limits. Eventually, Main Street and Wall Street will have to reconnect. According to super-investor Ray Dalio of Bridgewater Associates, we may have volatile and inadequate returns from stocks and bonds for some time to come. He advises investors to immunize their known liabilities and diversify well in competitive countries and across asset classes and currencies.