- While global assets continued to recover in May, year-to-date returns broadly remain negative except for fixed income.
- In no surprise, lagged economic data revealed the unprecedented depth of the economic impact of COVID-19, but re-opening the economy means the future economic data may not be as bad.
- Financial asset risks appear balanced as policy leaders are prepared to take action to ease further if the bear market persists.
May continued to bring some welcomed good news for investors. Investor risk sentiment improved. Volatility continued to decline toward its historical average while COVID-19 infection rates decreased and testing capabilities increased. Global risk assets continued to recover from first-quarter losses in May, although they broadly remain negative year-to-date. Support for risk assets also came in the form of clear forward guidance from the Federal Reserve and global policy leaders that more easing is coming.
With Congress debating additional fiscal stimulus in the U.S., the European Central Bank (ECB) expects to ease monetary policy at its June meeting by raising the Pandemic Emergency Purchase Programme (PEPP) by €500 billion to €1.25 trillion. There is even speculation the ECB may extend its asset purchase program beyond 2020.
Amid a backdrop of more accommodative policy measures, investor risk sentiment improved in May and fixed income asset classes generated positive returns. Within global fixed income, U.S. Treasury yields ended the month mostly unchanged, but credit spreads fell toward historical averages, most notably in riskier segments of the market. Core U.S. bonds gained 0.5% in May, bringing the year-to-date return to 5.5%. U.S. High Yield bonds returned 4.4% however remain negative for the year.
For the second time in as many months, a late-month rally lifted small-cap stocks over large caps. The Russell 2000 ended 6.5% higher while the S&P 500 returned 4.8%. However, year-to-date returns remained in negative territory for both. Recent U.S. dollar strength waned in May, a welcome reprieve for international developed equity investors, but rising geopolitical tensions weighed on emerging market returns. Global developed stocks (MSCI EAFE Index) returned 4.4% in May, but emerging market equities (MSCI EM Index) rallied just 0.8%. Year-to-date, both indices remain down 14.3% and 16%, respectively.
Within real assets, a historic rebound in crude oil prices (+88.4%) lifted Midstream Energy nine percent. Expectations for better economic data and relatively attractive yields in a low rate environment lifted Real Estate Investment Trusts (REITs) 0.2% in May. Year-to-date, Midstream Energy and REITs are still down 30.3 and 21.1%, respectively.
While global assets continued to recover from the first quarter sell-off in May, unemployment data, reported with a one-month lag, revealed the unprecedented damage done by the global COVID-19 pandemic. From March to April, the U.S. unemployment rate jumped from a 50-year low of 3.5% to a 90-year high of 14.7%. Initial jobless claims rose more than 10 million since April, bringing total job losses since March 14 to more than 40 million, lifting the consensus estimate for the May unemployment rate close to 20%. As the economy re-opens, continuing claims data, released weekly, should serve as a barometer for the speed and magnitude of the recovery.
Since household consumption represents approximately two-thirds of the U.S. GDP, it’s no surprise that second-quarter real GDP forecasts are staggering. However, it’s worth remembering that changes to real GDP growth are reported as an annualized figure. For example, the Atlanta Federal Reserve’s GDPNow model estimate for real GDP growth in the second quarter is -51.2%, which roughly translates to a $2.4 trillion decline from the first quarter. The second-quarter estimate may be revised higher as the economy re-opens or additional fiscal stimulus aids the hardest-hit segments of the economy, namely households and businesses. On a positive note, global business activity picked up from April, but remained weak.
The dichotomy between rising financial asset prices (forward-looking) and historically weak economic data (lagged) has been stark this quarter. However, market risks appear balanced. Aggressive monetary easing, the prospect of more fiscal stimulus and falling infection rates support the sharp rebound in risk assets. On the other hand, it will likely take the economy years to recover from the shutdown, valuations are relatively less attractive today than at the end of the first quarter and a second wave of infections is possible. Lastly, bear markets associated with recessions usually last longer than four weeks.
What does this mean for investors? We are continuing to update and examine our capital market assumptions and assess the implications for our clients’ portfolios. Unless you have a change in objectives or cash needs, we encourage you to maintain the established strategic asset allocation rooted in fundamentals. Timing markets correctly is very challenging, especially in today’s environment. Investors should keep their investment horizon in focus and not allow emotions to influence portfolio positioning.
For more on asset class performance in May, view our recent Market Recap.