With economic indicators turning negative, we strongly favor investment grade bonds over U.S. stocks and their international-developed market counterparts.
March 2020 Market Commentary
Over the past month, the global equity markets experienced one of their most volatile periods in modern history. Global equity markets fell for the third month in a row, and many regions saw their largest monthly decline since 2008. This was largely driven by COVID-19 (a.k.a. the corona virus) spreading across the globe, leading investors to a “risk off” sentiment. Within the U.S., large caps strongly outperformed small caps, returning -12.4% versus -21.7%. U.S. equity volatility, as measured by the VIX Index, increased +33.5% to 53.5 – reaching the highest level ever intramonth. Abroad, international developed stocks performed similarly to emerging markets, returning -12.4% versus -12.9%.
The U.S. ten-year yield fell forty-eight basis points (bps) and ended the month at +0.67%. The significant drop was driven by the coronavirus and its potential impact on global growth. The Federal Reserve cut its policy rate by 50 bps on March 3rd. This was the central bank’s first intermeeting cut since the financial crisis. On March 15th, the Federal Reserve decided to cut an additional 100 bps as policy makers became increasingly concerned around the economic consequences of the coronavirus.
The USD rose +3.1% on the month. At the beginning of the month, the USD was weakened by the first interest rate cut. However, central banks across the globe (Canada, Australia, England and Norway) quickly followed suit and a flight to safety supported the USD. Later in the month, the White House and Congress reached a deal on a two trillion-dollar stimulus package (approximately 10% of GDP), and the largest ever unemployment claims number led to further modest depreciation.
The price of crude oil declined -54.2% as a supply side price war between Saudi Arabia and Russia dominated the market. Deteriorating demand for oil due to the coronavirus intensified the losses. Transport fuels such as gasoline and jet fuel were affected by several airlines grounding flights indefinitely.
Gold prices rose +1.1% and reached a seven-year high intra-month. Physical gold saw high demand as retail investors bought the metal for protection against the turmoil from the coronavirus. Gold was negatively affected by investors having to free up cash to meet margin calls, as they sold liquid assets such as gold.
Short Term Market Outlook
Our proprietary leading economic indicator declined month-over-month and moved into negative territory. This reading was largely driven by record-breaking unemployment claims during the month.
QS Leading Economic Indicator
Our outlook for U.S. stocks versus investment grade bonds has moved from neutral territory to strongly favoring investment grade bonds. This is being driven by the decline in the QS leading economic indicator and tighter leverage conditions. The valuation factor, which compares the earnings yield of the S&P 500 relative to the ten-year treasury yield, continues to support stocks.
In U.S. fixed income, we forecast that investment grade bonds will strongly outperform high yield over the near term - this reading is at its highest level since 2008. Within the model, the widening of the spread between these assets and the sharp increase in equity volatility are driving the preference for investment grade bonds.
We believe that U.S. stocks are positioned to outperform versus their international-developed market counterparts, a change in our 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. International-developed markets are supported by valuation, which compares the forward price-to-earnings ratio in the U.S. versus their international counterparts.
European bonds are expected to outperform European stocks in our model. This view is being driven by the QS stock bond model and equity price momentum. Valuation, as measured by comparing European equities earnings yield to the ten-year government yield, continues to support European stocks.
Asset Class Preferences
Asset Class Preferences are based on QS Investors proprietary quantitative factor models. These rules-based financial models use a combination of indicators that analyse asset valuations, investor sentiment, and the broad economy.
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All data source Bloomberg and CNBC, as of 3/31/20, 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. Large Cap Equities represented by the S&P 500 Total Return Index; U.S. Small Cap Equities represented by Russell 2000 Total Return Index; and the U.S. Dollar (USD) represented by the Bloomberg Dollar Spot Index.
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.
The forward P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.
Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
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.
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.
USD is an abbreviation for the U.S. dollar.
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.
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The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
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