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The Brave Report: Market Commentary for June 2020

Click here for .pdf version of this report: The Brave Report-June 2020

In these reports, my job is to take all that is going on in the world and discuss how I think those variables are going to impact the financial markets and the economy. With almost every issue, there is a financial impact.  There are winners, losers or opportunities and it is my job to identify them.  However, there are some issues or events that are more important than just economics.  So even though my job is the financial perspective I would be remiss if I didn’t mention anything about what is currently going on in this country before jumping into my normal report.

This country has a deep wound that has been festering for years.  For some in this country, this wound of racial injustice is ever-present.  It impacts all aspects of their life, debilitating opportunity and forcing them to live in a constant state of pain or oppression. However, far too many in this country find it easier or more convenient to ignore this wound or simply try to put a band-aid on it and continue to move on with our lives.  Worse than this, there is a large percentage of the country that has convinced themselves that this wound doesn’t even exist or is not their problem to worry about. But whether you feel this pain yourself or are privileged enough to avoid it, it impacts us all on a societal level. It is not a red or a blue issue, a right or a left issue. It is an all of us together issue. Unless we as a country take proper steps to really treat this wound then it will continue to fester and kill our society from the inside.

I don’t know what the right way to treat this wound is, but it is very apparent that what we have done so far is not working.  So now, more than ever, we need to come together as a country to develop a solution. This solution can’t just mute the pain or cover it up but needs to actually treat the root cause. No matter how we are feeling, triaging or understanding this wound on an individual level, it is times like these that we must all listen to those who feel the pain of this wound most acutely in order to understand and treat it.  We must all understand that this pain is there and that it can’t be ignored anymore. This wound is not just a scratch that will heal quickly but a wound that will take years and repeated treatments to heal. The process will not be easy and many in this country will have to acknowledge uncomfortable truths about ourselves and our society.  However, if the proper steps are taken it is not just those that feel the pain that will be the beneficiaries, we, as a country, will come out as the winners.

Market Overview

The recovery rally continued in May as we saw the Nasdaq surge another 7.5% to reach back toward the all-time highs seen in February. The S&P 500 and Dow Industrials also surged, both gaining around 4.5%. While the Nasdaq again led the gains, near the end of the month we started to see a rotation from the “stay at home” stocks into recovery stocks. This created a sharp rise in some of the more beat up sectors as traders showed optimism about a swift economic recovery.  We also saw some chasing throughout the month as investors that had missed the initial bounce off of the March lows and had bet on a retest of those lows raced to not miss out on the entire recovery. This has put equities in an interesting position as a lot of the buying was indiscriminate. The economic data and fundamentals now need to play a bit of catch up.

Things remained pretty calm on the fixed income side throughout the month with rates remaining relatively range-bound. The 10-year bounced between a yield of 0.6% and 0.75% throughout the month. As we start to get some more economic data about the recovery in the next few weeks I expect the pressure to be to the upside for rates.  The expectation is for the virus to weaken throughout the summer and this should mean full steam ahead for reopening economy.  However, the real long-term test will be how things progress into the fall.  If progress toward a treatment or vaccine continues on a rapid pace than this recovery could be for real. This would lead to an increase in rates. But, if we see any setbacks and a resurgence of the virus in the fall then I expect us to return to this range we have been in for the last few months.

Tailwinds: One of the key characteristics of the market over the last month has been a rotation back into cyclical stocks.  Many of these stocks were the big losers on the way down as the outlook for the economy looked dire.  Even in the first phase of the bounce off the lows many of these stocks remained depressed as investors chased the defensive and stay at home names. Now, a number of tailwinds have emerged, and a lot of cash is pouring off the sidelines and looking for a place to go.

  • The Fed and Stimulus: The major tailwind in the market has been the massive fiscal and monetary policies implemented over the past few months.  The Fed basically came out and injected enough liquidity into the markets to backstop almost every asset. While I still expect a number of bankruptcies to occur coming out of this (especially on the small business side of things) the Fed has told most businesses that they are there as a lender of last resort.  By removing these downside tail risks, companies don’t have to just spend this time trying to stay afloat but are able to get back to business as usual.  On the stimulus side, we have seen trillions of dollars plugged back into the economy to help support those that are out of work and allow small business to weather the storm.
  • Virus progress: We have also seen rapid progress on the health side of things. The possibility of a vaccine being available by year-end is becoming more of a reality and we have seen infection numbers and mortality drop rapidly over the last month.  Much of this can be attributed to weather and the precautionary steps we are all taking as individuals but with many states reopening over the past month, there has been a fear that we would see a rapid increase in infections.  This hasn’t materialized as much as feared.  I know we are far from out of the woods on this front and things could change rapidly, especially with so many people gathering together for protests, but this summer reprieve from the virus that some health experts predicted is playing out.  One of the key variables that we will all have to monitor is if we see a resurgence in the fall as the weather cools.  On top of this, it will be important to monitor how states and individuals react to any hotspots or virus outbreaks as many may be a little more reluctant to lock down a second time.
  • Chasing: The last major tailwind we are seeing in the markets is what I call the FOMO (Fear Of Missing Out) trade.  During the initial selloff and subsequent bounce, we saw a lot of “smart money” and retail investors alike raising cash and waiting for another market pullback or retest of the lows before putting that money to work.  That pullback never occurred so all of these investors that still have cash on the sidelines are now rushing back into the markets to try not to miss the entire recovery.  Rather than put this money into the high-quality names that have already bounced all the way back (for fundamental reasons I should point out) and are sitting at all-time highs these investors are pouring money into the really beat up cyclical names in hopes that they can make up ground with the names that are still well off their highs.  This kind of chasing has been driving the markets over the past few weeks.  You can easily see it happen as various names bounce 10-20% overnight or during one trading day.  This buying is not just because these investors like these companies and think they will perform well coming out of this but there is a rush to not be the last one in the door

As we look at these three tailwinds, the first two have legs and should be the factors that help to lead us out of this crisis.  The last one, however, gives me pause and could be dangerous for some investors.  Just as panic selling on the way down should be avoided, panic buying on the way up can be equally as risky. Yes, I agree that many of these names were very undervalued from a long-term fundamental standpoint but many of these beat-up names were down for good reasons. They should be down because even if we eradicate this virus in short order, the virus will have lasting impacts on human behavior and some companies will see a negative impact on their fundamentals because of this.

Now, if you are a trader and are getting in and out of some of these names for a quick profit, be my guest.  But for the disciplined long-term investor, I would stress caution during a time like this.  At some point, the fundamentals have to catch up with the stock price. This is true to the upside and the downside.  If you truly like some of the names that have been bought heavily over the last few weeks, I would advise you to not just run out and try to chase them.  Identify them and find a price point where you would like to buy them.  If this initial pop fades than you are there ready to buy. If not, you have that capital ready for another opportunity.  This extra capital could also come in handy if we see any virus resurgence in the fall or the economic recovery not happen as rapidly as is currently being priced in.

Strategy Commentary

I continued to maintain my equity exposure over the past month. While the market continued to surge, I am still a bit cautious of going all-in on equities.  When the buying becomes indiscriminate it means that many names are getting bought for no reason other than they were well off their highs.  This doesn’t factor in that many of the names may deserve to be way off their highs.  When cash is flowing into names at such a rapid pace and we see these huge daily gains it is a sign that fundamentals are not being considered at all.  We are just seeing the FOMO trade as investors race to get back in.  At these times, I tend to remain cautious and only look to add on any weakness to those names and sectors I like for the long term, not just the flavor of the week.

Domestically, I continued to maintain my overweight to Technology. This served me well for most of the month. It can be tempting to rotate into some beat up sectors like financials or the travel sector as money flows that way but I still think there are too many long term uncertainties in these areas to make full portfolio shifts.  I would rather miss out on some short-term upside then chase these sectors and risk them pulling back again should lockdowns need to be reinstituted.

I shifted to underweight Europe a few months ago on an expectation that the US would better weather the economic storm and have a greater ability to stimulate the economy.  This showed to be the case, but we are now entering a phase where Europe and Asia are opening quickly and may start playing some catch up to the US.  I have not added back to these positions yet but could be looking to rebalance back into some of these areas as they continue to show strength.  I will also be looked at select emerging markets.  With cases surging in South America I will probably stay away from that region but will continue to try to identify opportunities in Asia.

While I did miss out on the drop in rates to start the year, we are now in a position where the pressure is to the upside on rates.  For that reason, I will continue to maintain my neutral to underweight allocation to fixed income.  If we see any negative news on the health side of things, I will be quick to add back to these positions.