Market analysis

6.29.20 | Market News

At a glance

Rising COVID-19 infections dampened investor sentiment, leading to a decline in riskier asset classes. Improving economic data was a positive, but it gave way to concerns of a slowdown in reopening.

10.8%

Year-to-date return for Information Technology stocks through June 26.

“Demand for assets as diverse as office buildings and oil needs to recover for real assets to trade at higher levels.”

- Kevin Weigel, CFA, Vice President, Head of Real Assets Research, U.S. Bank

Term of the week

 

Real assets – Physical assets that have an intrinsic worth due to their substance and properties. Real assets include precious metals, commodities, real estate, land, equipment and natural resources.

Global economy

Quick take: Growing concerns over increased COVID-19 spread in the Sun Belt overshadowed improving economic data, pressuring markets last week.

Our view: The sharp stock market rally early in the second quarter due to reopening has stalled recently on rising concerns about the acceleration in the coronavirus’s spread. We see these risks as generally balanced with the positive economic data, reinforcing our cautiously optimistic outlook.

    • The spread of COVID-19 continues to increase across the United States, centered in the western and southern regions. Texas Governor Greg Abbott rolled back reopening plans, including closing bars and reducing occupancy in restaurants. Other politicians in the affected regions have also warned that pauses in reopening are possible if spread worsens.
    • Global purchasing manager surveys showed improvements from last month, although contractions continue throughout the world. U.S. composite activity contracted for the fifth straight month, though the decline was the slowest in four months. Reopening progress worldwide has helped survey numbers move closer to expansion territory.
    • U.S. personal income and spending data showed declining government support for the economy, with still-tepid consumption activity. Fiscal support was still extreme, largely due to unemployment insurance payments, though down from April’s individual check-fueled injection. Salaries and wages rose sharply since last month, though not enough to prevent personal income from declining in aggregate. Personal consumption expenditures posted the largest monthly increase on record, though they remain down sharply since last year.

Equity markets

Quick take: Equities retreated last week, erasing gains for the month. COVID-19 remains omnipresent, negatively impacting investor sentiment and slowing the reopening of state economies, while tempering expectations for economic growth in the second half of 2020. Our “glass-half-full” outlook is largely bolstered by non-problematic inflation, massive monetary and fiscal stimulus and indications of medical progress toward a COVID-19 vaccine.

Our view: The duration and impact of COVID-19 remain unknown; the path toward normalcy requires time and is subject to much uncertainty. We expect volatility to remain elevated until COVID-19 treatment and prevention solutions become readily available, presumably in early 2021.

    • Performance of U.S. equities remains lackluster. The S&P 500 is approaching mid-year down roughly 7.0 percent, with nine of 11 sectors in negative territory. Information Technology remains a standout, advancing 10.8 percent year-to-date and 3.9 percent for June as of Friday’s close. Conversely, Energy and Financials are the two worst-performing sectors for the year, declining 39.2 percent and 26.5 percent, respectively.
    • Several factors have contributed to price declines in late-June: The S&P 500 was due for some consolidation following the 40 percent rally since the March 23 low, companies are in a quiet period leading up to the second quarter reporting period, COVID-19 cases and hospitalizations are rising in southern states, institutional rebalancing is occurring as quarter-end nears, and the change a potential Biden presidency could bring is being considered.
    • Second quarter earnings reports are a near-term catalyst. Earnings reporting unofficially begins during the second week of July. Expectations are low, with year-over-year revenue and earnings projected to decline approximately 11 and 43 percent, respectively, according to FactSet.

Bond markets

Quick take: Concerns over rising COVID-19 cases drove Treasury bond prices higher (yields lower) and riskier bond prices lower (yields higher). U.S. Treasury yields remain rangebound despite last week’s move, and municipal and corporate bond yields compared to Treasuries remain wider than historical norms.

Our view: We see opportunities to add yield and keep portfolio quality strong by favoring high-quality corporate and municipal bonds over Treasuries. We expect Treasury yields will continue to be stable, which favors taking on risk in line with benchmarks.

    • The Federal Reserve (Fed) continues to support capital markets through its bond purchase program, although these facilities have significant unused capacity. The Fed has ample bandwidth to expand utilization of existing programs if conditions warrant and have emphasized a commitment to supporting the recovery using all their tools. On Wednesday, the Fed will release minutes from its last meeting, which should provide insight into its approach going forward.
    • Corporate bond prices fell last week as investor risk appetite faded. Higher-rated corporate bonds held up relatively well, but lower-rated bonds suffered as COVID-19 cases rose. Investment-grade corporate bond issuance has set records as companies bolster cash balances, while investor demand is improving and yields compared to Treasuries remain higher than historical norms.
    • Municipal bond yields were stable relative to Treasuries despite the sell-off in similarly rated corporate bonds. The municipal bond market has been more resilient in recent risk-off (less aggressive) market environments, due to improving new issuance conditions, Fed support and less dire fiscal outlooks. Lower-rated issuers may still struggle with declining revenue, and we favor higher-rated municipal bonds.

Real assets

Quick take: Fears of a second wave of COVID-19 created uncertainty about the strength of the economic recovery and pressured most real asset sectors last week. Domestic crude market fundamentals caused a decline in the price of crude oil, and energy-related equities experienced even larger losses.

Our view: Weak performance in real assets last week brought valuations closer to implied growth rates. Energy equities fell 6 percent to 10 percent but still have more downside. Demand for assets as diverse as office buildings and oil needs to recover for real assets to trade at higher levels.

    • Infrastructure and Utilities traded in line with the broader market last week while Real Estate trailed by 1 percent. In Real Estate, the hotel, retail and office sectors experienced outsized losses, but still have more downside risk. Barry Sternlicht, founder of Starwood Capital, a luxury hotel operator, spoke very negatively about New York office and hotels during a Bloomberg interview, which added to the Real Estate market sell-off.
    • Domestic crude production rebounded strongly last week, and inventories increased unexpectedly. Rising production from any of the major suppliers is negative for the crude market right now.
    • Commodity-based equities trailed the broader market considerably last week, with crude prices weakening. COVID-19 fears and increased inflationary expectations are a bad combination for commodity-based equities.
    • Industrial metals and precious metals rose last week, with copper and gold each up 1.6 percent. Both remain in a bullish trend. Declining interest rates were the primary catalysts for the move. Additionally, the potential for inflation resulting from central bank policies should keep metals prices supported.

This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

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