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May 2020 Monthly Review

"The Rubber Band Market"

By Loyd Johnson, Chief Investment Officer
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Loyd Johnson PhotoA Look Back

The Rubberband Man was a Spinners classic song released in 1976 that reached #2 on the Billboard chart. It was the tune blaring in the locker room when we reported for football camp my freshmen year of college. When I heard it recently, it reminded me of the mighty spring-back our markets have experienced over the last two-plus months.

Many market observers have speculated on what letter in the alphabet will best describe the eventual economic recovery from the global Coronavirus pandemic. The most optimistic letter, of course, would resemble a "V." The 35% plunge in the S&P 500 from the February 19th all-time highs to the lows of March 23rd, would be followed by a similarly aggressive march back up…like the letter.

Other letters like a "U" or "L" have also been discussed, but it is growing ever more difficult to witness the market action since March 23rd and not shout out a big ole V…perhaps not for victory just yet, but nonetheless signaling the rapid market recovery of the last two months. May saw every equity asset class continue their snapback, as Small-cap domestic stocks outperformed the Large-cap S&P 500, 6.51% to 4.76%.

By month-end, the bellwether S&P 500 was down less than 5% for the year, a nearly impossible thought as spring started in March. With the Fed lowering the Fed Funds rate to zero in March, Money Market funds and other near-term cash alternatives are providing little return. High Yield and Municipal bonds, however, outperformed as some of the credit worries associated with each temporarily waned. This elastic return continued even as various economic releases displayed the negative effect the pandemic and the unprecedented economic shutdown has had on individuals and companies, both big and small.

A Look Ahead

We believe that this recent market rally has been fueled by three main drivers:

  • 1. Historically Low Discount Rates—Ultimately stocks are priced on the net present value of future earnings and with the 10 year treasury yield around 0.6%, a dollar of earnings 10 years from now is worth almost as much as a dollar today. If you have confidence in a company’s longer-term earnings, you might be willing to pay more today.
  • 2. Monetary and Fiscal Stimulus—The CARES act alone, passed in March, accounts for over 10% of America’s annual GDP. In addition, the Fed has already added over $4 trillion to its balance sheet to provide "unlimited" liquidity to unstable markets. The damage caused by the pandemic has been massive, but so too has the amount of various relief efforts.
  • 3. Expectation of Better News—After the unprecedented global lockdowns that began in early March, countries around the world have slowly begun the reopening process. Many believe that the economic decline has already reached rock bottom, with nowhere to go but up. Numbers seen in May on the manufacturing and jobs front already indicate this. Although true, we do believe the rebound will be uneven as certain sectors will fare better than others. Travel and tourism is likely to face a much slower recovery as people rethink their normal vacation plans.

We talk often about the resilience of markets and economies and what we have seen over the last couple of months is evidence of this. We do not believe that market volatility is gone forever and it is likely that we will experience some additional pain on this recovery path…but for now we enjoy the rebound of the rubber band market.