Weakness in manufacturing data, hours worked and building permits is helping to keep our proprietary leading economic indicator in negative territory, despite overall improvement over the past month.
June 2020 Market Commentary
For the third month in a row, global equities rebounded from the notable decline that occurred in March. This was driven by easing of lockdown restrictions across the globe, however at the end of the month, some of economic reopening was delayed as new cases rose in some U.S. states. Within the U.S., small caps outperformed large caps, returning +3.5% versus +2.0%. U.S. equity volatility, as measured by the VIX Index, rose +10.6% to 30.4 – well above the long-term average of ~ 20. Abroad, emerging markets outperformed international developed stocks, returning +6.7% versus +2.7%.
The USD oscillated throughout June and finished down -0.7%. Strong economic data at the beginning of the month, including Nonfarm Payrolls, Retail Sales and the Philadelphia Fed Business Outlook led the currency to depreciate. However, Fed Chairman Jerome Powell stated that there was a “long road” to recovery. That statement, combined with COVID-19 case surges in Texas, California and Florida, led the USD to rally. Additionally, the White House announced potential new tariffs on European Union exports, providing additional support for the safe haven currency.
The U.S. ten-year yield rose one basis point and ended the month at +0.66%. At the beginning of the month, the ten- and two-year spread reached seventy-two basis points, the highest in several months. This was driven by hopes of a quicker economic recovery as strong U.S. employment data was released. During the Federal Reserve meeting mid-month, the Fed signaled that it intends to keep rates low and this led the yield curve to flatten.
The price of crude oil rose +10.7% after the significant +88.4% rally in May. The commodity rallied at the beginning of June on positive risk sentiment and OPEC announcing it would maintain production cuts. Later in the month, the resurgence of COVID-19 cases and the potential for the reintroduction of lockdowns led oil prices to decline. Additionally, prices fell further after a report on June 24th showed that U.S. crude stockpiles rose.
Gold prices increased +3.7% and were supported by the Federal Reserve’s announcement of continued low interest rates and fears of a second wave of COVID-19. The asset reached an eight-year high after certain U.S. states saw a spike in new cases.
Short Term Market Outlook
Our proprietary leading economic indicator remains in negative territory, however it has improved over the past month. This negative reading is driven by weakness in manufacturing data, hours worked and building permits.
QS Leading Economic Indicator
Our tactical stock-bond model has improved and continues to favor U.S. stocks versus investment grade bonds. This reading was driven by the improvement in the QS leading economic indicator and continued strength in 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 investment grade bonds will strongly outperform high yield over the near term, a change in view compared to last month. This is being driven by the increase in U.S. equity volatility month-over-month and the widening in spread between the two asset classes.
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 abroad and supports U.S. equities. Equity price momentum also prefers U.S. stocks.
European bonds are expected to outperform European stocks in our model; however, the strength of the signal has declined since last month. Weakness in European Leading Economic Indicators are continuing to drive the preference for European bonds.
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 analyze asset valuations, investor sentiment, and the broad economy.
All data source Bloomberg, as of 6/30/20, 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.
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 Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.
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.
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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.
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