Investment outlook

Second Quarter 2020
Market news

At a glance

The coronavirus pandemic is leading to a global economic slowdown and pressuring risk asset prices in the near term. The length of social distancing policies is a key driver of the magnitude of the likely contraction and market pressures. Low interest rates and growing government spending policies should provide some support and give us optimism for recovery late this year.

Thoughts from our Chief Investment Officer

We are optimistic about the opportunities that lie on the other side of this event, but mindful that across all asset classes, investors will be reacting to a wave of news stories and reports from the medical and financial communities. We continue to emphasize to clients the need to live and invest within their means, and for clients to emphasize capital preservation and liquidity first.

Eric Freedman, Chief Investment Officer, U.S. Bank Wealth Management

Global economy

Quick take: The coronavirus epidemic is slowing the global economy.

Our view: We expect to see a multi-speed rebound in late 2020 as the world economy recovers from the coronavirus pandemic. (Some regions will recover more quickly than others.)

    • Social distancing measures around the world to combat the coronavirus pandemic slowed the global economy before a likely recovery late in 2020. Government responses to the outbreak should provide some recovery in activity this year.
    • In the United States, economic growth is under pressure, but likely to recover late in the year. Interest rate cuts from the Federal Reserve (Fed) and fiscal stimulus through government spending could lift growth once social distancing measures are lifted.
    • Inflation in the U.S. is likely to ease in coming quarters as economic activity slows to combat the coronavirus and adjusts to the collapse in oil prices.
    • The 2020 Presidential election will move into focus late this summer. Wage growth and consumer confidence are key indicators to watch for to anticipate the likely election outcome.
    • We expect emerging markets, including China and other trade-oriented economies, to see recovery from coronavirus impacts this year.
    • The decline in oil prices is bad news for oil producers. In addition, COVID-19 hurts the fragile financial systems of Europe and Japan, which were struggling before the coronavirus outbreak.


Equity markets

Quick take: Corporate earnings growth lacking visibility in the face of COVID-19, depressed oil prices and slowing global growth continue to weigh on equity prices while overshadowing the attractiveness of longer-term opportunities.

Our view: We expect a great deal of volatility as long as COVID-19’s duration and impact remain unknown, oil prices stay depressed and earnings visibility is lacking.

    • Year-to-date performance is negative and broad-based. All 11 S&P 500 sectors declined in the first quarter, led by the 51.1 percent and 32.3 percent declines of Energy and Financials, respectively. In addition, valuations are potentially misguided due to uncertainty surrounding earnings.
    • The fundamental backdrop for U.S. equities is mixed. Inflation is restrained, interest rates are low and fiscal policy is expansive. This normally supports a risk-on (more aggressive) investment posture. However, the pace of earnings growth is trending lower. Slower earnings growth typically implies muted returns.
    • Election-year rhetoric is contributing to overall equity price volatility and investor angst, which we expect will continue leading up to the November election.
    • Opportunities exist in all market environments. Amid our cautious and conservative bias, we are mindful that opportunities exist within each asset class in all market environments. U.S. equities’ dividend income profile improved, with nearly 75 percent of S&P 500 companies offering dividends above the 10-year Treasury yield of 0.67 percent, as of March 31. Also, the digital transformation reflects change and investment opportunity. Artificial intelligence, machine learning, robotics and automation, and the electrification of work and play are among compelling investment opportunities for investors looking toward year-end 2020 and beyond.

Foreign markets

Quick take: We view foreign developed equities’ growth prospects less favorably than U.S. large company alternatives, and have a cautious view of emerging markets in the current environment. China’s potential emergence from the coronavirus is a key variable to watch.

Our view: COVID-19’s spread and duration and government policy impacts on businesses and consumer behavior cloud developed market growth prospects in the near term. Long-term thematic considerations, less attractive alternatives and China’s potential emergence from restrictive containment policies keep our emerging market thesis intact.

    • Fundamentals are in flux and we view 2020 estimates skeptically. Analysts continue to revise full-year sales and earnings growth expectations lower in developed and emerging markets as virus, government policy and oil price impacts become more visible.
    • Monetary policy is supportive, but the virus’s spread, containment efforts, fiscal responses and, ultimately, individual country outcomes will vary across the region.
    • The economic backdrop for foreign emerging equities presents both challenges and opportunity. Economic indicators reflect the virus’s significant disruption to China’s economy, but news reports suggest the country may be the first to emerge from restrictive containment policies.
    • The U.S. dollar remains a major headwind. Most emerging market currencies trade at historically low values compared to the U.S. dollar, which increases dollar-denominated costs for emerging market borrowers and is a headwind to growth prospects.

Bond markets

Quick take: Treasury bond yields plummeted to all-time lows (prices rose). We expect volatility will persist despite aggressive action by the Fed. U.S. Treasuries outperformed virtually all other bonds in the first quarter, and we continue to emphasize high quality bonds until the path forward becomes clearer.

Our view: A large policy response from the Fed hasn’t been enough to quell investor fears in bond markets. A large-scale federal response and slowing spread of COVID-19 are perquisites to becoming more opportunistic. Ample high-quality bonds are important to deliver adequate portfolio ballast against riskier holdings. Corporate rating downgrades have just begun, and defaults among lower quality bond issuers are likely.

    • The Fed slashed interest rates to almost zero and announced numerous programs to support markets. At times in the first quarter, the Fed bought more government-backed bonds daily than they did monthly during and after the financial crisis of 2008. Other central banks across the globe took a variety of similar measures to ease strained financial conditions. We anticipate Treasury bond yields to remain low in the near term.
    • Treasury bond returns were strong, while corporate and municipal bonds posted losses. Fed rate cuts and their significant bond buying programs, investor demand for safe-haven assets, collapsing inflation expectations and falling growth expectations all contributed to rising Treasury prices and falling yields.
    • Corporate bond yield spreads (corporate bond yields compared to Treasuries) traded at their widest levels since 2009, both in investment-grade and high yield categories. However, they’re still a meaningful distance from the extremes of 2008. Spread levels are the widest in years but the bottoming process took a period of months during previous periods of extreme market stress. We haven’t seen the signs of stabilization needed to take a more aggressive stance at this point.
    • Municipal bond markets, like corporates, experienced rapid selling pressure and volatility. Investment-grade muni yields relative to Treasuries are near crisis-era levels, reflecting poor market liquidity and growing credit concerns. High yield municipal yields also rose, but are not near where they were during the 2008 crisis, despite large price losses. We are focusing on higher-quality investment-grade opportunities.

Real assets

Quick take: Declining economic growth rates due to the COVID-19’s spread dominated price action in all real asset sectors in the first quarter. Additionally, the oil price war between Russia and Saudi Arabia punished the energy sector.

Our view: Near-zero interest rates imply that most real asset sectors have more downside risk due to potential declines in demand.

    • All the defensive sectors ― Infrastructure, Utilities and Real Estate ― are now down significantly for the year. Growth concerns outweigh the decline in interest rates for these stocks.
    • Crude prices fell substantially in the first quarter and the market seems to be pricing in a sustained price war between Russia and Saudi Arabia. Prices can still move lower, but it appears most of the damage has been done.
    • Given low interest rates, ample central bank liquidity and a large quantity of negative yielding debt globally, there is plenty of price support for precious metals, such as gold.

Alternative Investments

Quick take: Hedge funds outperformed public markets in the first quarter, using hedging strategies and avoiding sectors hardest hit by the coronavirus and oil price war. Private equity capital raised to date allows investors to support businesses in the wake of slowing economic conditions.

Our view: Hedge funds will continue to reduce risk to growth sectors and take a more defensive posture until there is further clarity on virus and containment impacts on the economy. The rotation to more defensive sectors can help protect capital if markets continue downward. Private markets are flush with cash and offer enhanced return opportunities and diversification potential.

    • Heightened market volatility resulting in wide dispersion across regions, sectors and companies provides opportunity for hedge funds skilled in stock and bond selection to protect capital in the short-term and add value in the long-term.
    • Strategies like insurance-linked securities have little to no correlation to public markets and can provide portfolio diversification during times of market volatility. We expect these funds to provide a steady return and help reduce the risk of the client’s portfolio.
    • Private market cash ready for investment ― or dry powder ― is at historical highs, but within healthy range on a relative basis. We believe private markets will continue to offer enhanced return and portfolio diversification opportunities.
    • Slowing business activity could present investment opportunities in good businesses at discounts due to market stress. Also, overleveraged companies can present restructuring opportunities for special situations investors. Private debt funds, given their strong capital base, can act as liquidity agents for viable businesses.

For a more detailed commentary:

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