After spending most of May consolidating, stocks climbed higher in the final week (chart below). In Canada, the stock market was up appx. 3% for the month (-12% for the year) , while in the US, the S&P 500 was up appx. 4% in May (-7% for the year).
The S&P 500 in the US now stands at the same level as it was… just 7 months ago. Meanwhile, recent labour reports showed total employment back to where it was… 23 years ago.
Such a dichotomy between financial markets and the underlying economy has inevitably (and understandably) aroused scepticism among many investors. Yet, the divergence doesn’t appear to be the result of extreme exaggeration on the part of speculators. Daily trading volume is below average, and investor sentiment remains at a neutral level (chart below). There are several likely factors that are contributing to the stock market’s rise, and we will address some of the most significant ones below.
Jobs may come back quicker than expected - In "normal" times, heavy job losses tended to forecast further job losses to come - this was the case throughout the 2008/2009 recession, for example. However, the current recession differs significantly in the sense that nearly 8 out of 10 unemployed workers are on temporary layoff (chart below). It will unquestionably take much longer to get all of those jobs back than it took to lose them, but things may not be as dire as many had feared.
Low Interest Rates for Longer – As interest rates have fallen dramatically (chart below), a lack of alternatives may be forcing investors to seek riskier assets. This is especially true when considering the needs of pension funds and insurance companies. These large institutional investors are constantly receiving deposits and premiums, which must be immediately invested to fund future obligations. Consider that the dividend yield of the TSX index in Canada is currently 3.6%, when comparatively the yield on a 10-year Government of Canada bond is just 0.6% (the 30-year bond is only 1.4%!). Investors are getting 6X higher yield on stocks than bonds! The payoff for investing in equities seems reasonable IF investors are confident that the economic recovery is on track.
Strong returns, tend to follow strong returns - history tells us that stocks actually tend to do quite well after such periods of strong growth (not the other way around - as many would expect). For the quarter to date (Mar 31-May 29), the S&P 500 is up 18.2%. Returns of 8% and 15% on average have been experience in the three and twelve months that have followed similar strong quarters, over the past 50 years (below).
While the above reasons help to ‘justify’ the optimism we are seeing in markets, there are certainly good reasons to remain cautious. It may very well be that the economy quickly picks up without permanent damage, but we are still very much in the weeds. Recent weeks have brought an entire new set of challenges – renewed trade tensions with China, concerns with regards to Hong Kong’s independence and the terrifying unrest we are currently witnessing in the US - which among other negative outcomes, could potentially lead to a second resurgence in COVID-19 cases. We always hope cooler heads prevail, but remain prepared to take action if this is not the case.
With regards to addressing the recent concern surrounding the potential for a ‘second wave’ of the virus – our economic and strategy group put out some excellent commentary last week. In their opinion it is unlikely that Government’s would react the same way (severely shutting down the economy to reduce spread), if we were faced with the crisis again. While we had an indication of who was most vulnerable to the virus back in February, we now have the ‘hard’ data which shows that just 20% of the fatalities occurred in the working age population. If a second wave was to emerge – the likely action (in our team’s opinion) would be to focus on restricting the spread to those most at risk.
As always, please give us a call or send an email if you have any questions or concerns with regards to your portfolio. Also, if you have any last minute tax questions or require any additional information we are more than happy to help!
Stay safe and enjoy the Spring weather!