Our tactical model now prefers U.S. stocks to investment grade bonds, with U.S. stocks positioned to outperform their international counterparts.
May 2020 Market Commentary
For the second month in a row, global equities rebounded from the notable decline that occurred in March. This was largely driven by easing of lockdown restrictions across the globe, in addition to increasing optimism concerning a vaccine for COVID-19. Within the U.S., small caps outperformed large caps, returning +6.5% versus +4.8%. U.S. equity volatility, as measured by the VIX Index, decreased -19.4% to 27.5 – still well above the long-term average of ~ 20. Abroad, international developed stocks outperformed emerging markets, returning +4.1% versus +0.7%.
The US Dollar declined -1.2% in May, as weak economic data was paired with renewed U.S. and China tensions. At the beginning of May, the April unemployment rate was released; the 14.7% reading was the highest level in post-war history1. Retail sales were released mid-month and saw a -16.4% contraction month-over-month. At the end of May, President Donald Trump announced that the U.S. will “begin the process of eliminating policy exemptions that give Hong Kong different and special treatment” from mainland China – escalating tensions between the world’s two largest economies.
The U.S. ten-year yield rose three basis points and ended the month at +0.65%. On May 7th, the August 2021 Fed fund future turned negative, leading the two-year and ten-year to fall thirteen and six basis-points. President Trump then tweeted that the U.S. should be given the gift of negative rates – leading to the ten-year yield to fall an additional five basis-points. Fed Chairman Jerome Powell stated that negative rates were not likely, and this helped support the yield curve.
The price of crude oil continued its recovery from its March collapse and jumped +88.4%. Oil prices rose due to economies easing lockdown restrictions throughout the month and oil companies in North America reducing supply.
Gold prices rose +2.5% and reached an eight-year high. The commodity was supported by weak economic data and continuing record-high unemployment claims throughout the month. During the back half of the month, gold gains were tapered by Federal Reserve Chairman Jerome Powell stating that negative rates were not likely, positive news around a potential COVID-19 vaccine, and economies continuing to reopen.
Short-Term Market Outlook
Our proprietary leading economic indicator continues to have a significant negative reading. This is driven by record high unemployment claims and weakness in manufacturing data.
Our tactical stock-bond model now prefers U.S. stocks versus investment grade bonds, a change in view compared to last month. This reading is driven by loosening leverage conditions and the valuation factor. The valuation factor compares the earnings yield of the S&P 500 relative to the ten-year treasury yield.
In U.S. fixed income, we expect that high yield will outperform investment grade bonds over the near term, however the strength of this signal has moderated compared to last month. The decline in U.S. equity volatility month-over-month and the spread between the two asset classes supports high yield.
We believe that U.S. stocks are positioned to outperform versus their international-developed market counterparts, a similar view compared to last month. Yield curves in other developed markets are flattening at a faster rate than in the U.S., which we interpret as a sign of lower economic prospects and supports U.S. equities. Equity price momentum also prefers U.S. stocks.
European bonds are expected to strongly outperform European stocks in our model – this reading is at a record level. This preference is driven by a significant decline in European Leading Economic Indicators. Valuation, as measured by comparing European equities earnings yield to the ten-year government yield, continues to support European stocks.
Asset Class Preferences are based on QS Investors proprietary quantitative factor models. These rules-based financial models use a combination of indicators that analyze asset valuations, investor sentiment, and the broad economy.
All data source Bloomberg, as of 5/31/20, unless otherwise noted. Global Equities represented by the MSCI ACWI Gross Total Return Local Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; Developed Market Equities represented by the MSCI EAFE Gross Total Return Local Index; U.S. Small Cap Equities represented by the Russell 2000 Index; and U.S. Large Cap Equities represented by the S&P 500 Total Return Index.
1 Source: JPMorgan.
QS Leading Economic Indicator Index is a proprietary composite of economic data that QS Investors believes are significant in determining financial and economic conditions in the U.S. Past performance or any prediction or forecast is not indicative of future results. QS Leading Economic Indicator Index inception date is 1/2/1970.
A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.
COVID-19 is the World Health Organization's official designation of the current coronavirus disease.
Developed markets (DM) refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.
The earnings yield is the earnings per share for the most recent 12-month period divided by the current market price per share.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.
High yield bonds have below investment-grade ratings (BB, B, CCC for example) are considered low credit quality and have a higher risk of default.
Investment-grade bonds are those rated Aaa, Aa, A and Baa by Moody's Investors Service and AAA, AA, A and BBB by Standard & Poor's Ratings Service, or that have an equivalent rating by a nationally recognized statistical rating organization or are determined by the manager to be of equivalent quality.
Leading Economic Indicators (LEI) are measurable economic factors that change before the economy starts to follow a particular pattern or trend. While they are used to predict changes in the economy, they are not always accurate
The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.
A spread is the difference in yield between two different types of fixed income securities with similar but not identical characteristics, with the possible differences including creditworthiness, maturity date, or other factors.
U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.