- Stocks continued a ferocious rebound off the March lows on expanding breadth.
- Growth outperformed Value for the eighth consecutive month and the relative strength ratio (RLG/RLV) closed at a record high, eclipsing the prior dotcom high from February 2000.
- Crude oil rebounded from deep oversold, negative territory.
- Growing reports the Fed could implement yield curve control over negative short term rates by year end 2020 impacted stock and bond prices.
- The Fed’s balance sheet rose to a record $7.1T.
U.S. equities continued their ferocious rebound in May following its fastest ever 35% decline from record highs. The S&P 500 and the broader based Russell 3000 gained 5% last month, following 13% gains in April. The large cap indices have rebounded more than 40% off their respective March lows, while the small and mid-cap benchmarks gained more than 50%. The economic data is dismal and unlike anything seen in modern history. However, massive fiscal and monetary stimulus are, at the moment, providing a bridge towards a potential pickup in corporate earnings in 2021, as U.S. states and global economies begin reopening their economies, albeit slowly.
The stock market’s rapid V-shape recovery, and for some benchmarks a return into positive territory YTD, caught many by surprise given the dire economic impact of the global shutdown, and the escalating geopolitical and social unrest. Even the most recent days of widespread rioting and extensive destruction in major cities across the United States is not having an immediate negative impact on stocks.
The unemployment rate spiked from 4.4% in March to 14.7% in April, the highest on record going back to the 1940’s. A Bloomberg survey of economists expect it will rise to 19.6% for May, but then fall back toward 10% by year end. The most recent continuing claims figure dropped by 3.8 million to 21 million, offering a glimmer of hope for a potential rebound in the labor market carnage. Durable Goods Orders declined 17.2%, or -7.4% ex-transportation. Q1 GDP (2nd estimate) declined 5% with nominal consumption falling 13.6%.
Geopolitical tensions escalated on multiple fronts between the U.S. and China. Throughout May the Trump administration increased its COVID-19 blame rhetoric against China. Late last week the administration followed through on prior threats by terminating funding and its overall relationship with the World Health Organization, which it accuses of being strongly influenced by China. President Trump also announced he is taking measures to revoke Hong Kong’s favored trade status in response to a controversial new security law passed by China’s parliament that would essentially bar political protest in Hong Kong. Trump also threatened foreign companies listed on U.S. financial exchanges may have to abide by American accounting and audit standards. Yet remarkably equity benchmarks are up more than 40% from their March lows and valuations are at their highest levels since the dotcom era. The S&P 500 is trading at a 21.8x forward twelve-month PE ratio, a 44% premium to its 10-year average according to FactSet.
Just last week the EU broke long engrained austerity protocol and unveiled a 750 billion-euro fiscal stimulus package, which if agreed upon will represent a major step toward unifying the Union’s financial systems. Japan’s cabinet approved a new $1.1 trillion stimulus package, bringing its total COVID-19 spending to $2.2 trillion or 40% of GDP, according to Reuters. The U.S. aid program is $2.3 trillion. The House already approved an additional $3 trillion relief plan which Congress could pass in the upcoming weeks.
Strong gains were realized across the major benchmarks as stocks of all sizes and industries participated in the recovery. The small and mid-cap benchmarks were amongst the top performers, however they remain 16-18% below their 2020 highs reflecting their historic declines in Q1. Conversely the Nasdaq 100 closed out May with a 10% gain YTD, and within 2% of its all-time highs. While breadth measures continue improving vs. any point since the March lows, they are well below levels seen in February.
All eleven GICS sectors registered positive gains and were once again led by Technology (+7.1%). Materials (+7%) and Industrials (+5.5%) continued their rebound. Energy (+1.9%) was relatively flat after rebounding 30% in April. Financials gained a relatively modest 2.7%, though the space experienced wide price swings in both directions. For a brief period in early May, futures were pricing in negative overnight rates by the fall of 2020. Currently that is not expected until the middle of 2021. There is a growing expectation the Fed could paint the curve by year end rather than lowering short term rates into negative territory.
The growth vs. value debate picked up steam as value showed some late outperformance towards the end of May. For the month of May the Russell 1000 Growth Index (RLG) gained 6.7% and handily outperformed Value (RLV) which gained 3.4%. This was the 8th consecutive month growth outperformed value. Since inception in the late 1970’s, the longest streak of growth outperformance is nine months, which only happened once, December 2007, just two months after the stock market peaked in the prior cycle.
Positive momentum clearly is in the growth camp. It is worth noting the ratio of the Growth Index (RLG) to Value (RLV) reached a marginal new all-time high at the end of May. The prior high was made more than 20 years ago in February 2000 (chart below). Technicians typically expect increased overhead supply and thus temporary resistance when a security or ratio first reaches a prior major price level, which would suggest value is due to outperform.
Dollar, Rates, and Commodities:
The U.S. dollar lost ground to the euro late in the month seemingly on reports of a coming sizeable stimulus package by the EU. The U.S. Dollar Index (DXY) declined a modest 0.7% for the month, but in the final two sessions it broke down below both its 200-day moving average, as well as a six-week support level which suggests it could be in the early stages of a new downtrend.
Rates were relatively muted across much of the curve. The long end (10YR and 30YR UST’s) remained range bound for the 2nd consecutive month, while the belly (2YR and 5YR UST’s) hovered just above 2020 lows. In early May futures were pricing in negative overnight rates by October 2020, but that has been pushed out into the middle of 2021. Market whispers think the Fed is more likely to paint the yield curve by year end 2020 which would be preferable to lenders. The volatility on the short end was partly to blame for the KBW Regional Bank Index (KRX) declining nearly 23% over the first two weeks in May, before then rebounding more than 37% and briefly going positive in the final week.
Crude oil rebounded from four consecutive monthly declines including negative prices in April. The June contract gained 72% to $32.50. Spot gold gained 2.6% but has largely been range bound since reaching $1,747 back on April 14. Copper gained 3% but remains down more than 11% YTD. The Bloomberg Commodity Index (BCOM) gained 4.4% in May, but is down more than 21% YTD.
Rising prices and improving breadth are positive signs providing hope the worst of the crisis is in the rearview mirror. With all 50 U.S. states and global economies now in the early stages of reopening, the strength of new coronavirus cases will be one of many factors driving markets and economic activity. Future gains for the major benchmarks will likely need to see a continued rotation into the previous underperforming cyclicals and value stocks, given the relatively high valuations amongst many of the better performing growth names. Seasonality is a factor worth keeping on the radar as the summer months (August and September) are historically amongst the worst performing on average. The Federal Reserve is not expected to act anytime soon, but reports are increasing it could reach into the monetary toolkit and implement some type of yield curve control, the likes of which is already underway in Japan and Australia. Since the start of March the Fed’s balance sheet has grown 70% to $7.1T.
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