Our tactical stock-bond model continues to favor investment grade bonds over U.S. stocks.
April 2020 Market Commentary
Over the past month, global equities rebounded from the notable decline that occurred in March. This was largely driven by a decline in the spreading of the COVID-19 (a.k.a. the corona virus) and some countries began to partially re-open their economy. Within the U.S., large caps returned +12.8% - it’s highest monthly return in decades. U.S. equity volatility, as measured by the VIX Index, decreased -36.2% to 34.2 – after reaching record levels in March. Abroad, emerging markets outperformed international developed stocks, returning +8.8% versus +5.5%.
The Federal Reserve announced a lending program that will provide up to $2.3 trillion in loans to support the economy. Later in the month, the Federal Reserve kept the policy rate target range at 0.0% - 0.25% to provide additional support. Both measures helped dampen the effect of the large jump in unemployment claims, where approximately twenty million people filed for an initial jobless claim over the month. Disappointing economic data continued to be released throughout the month, including the U.S. composite PMI dropping to 27.4 from 40.9 one month earlier.
The U.S. ten-year yield fell three basis points and ended the month at +0.64%. On April 21st, the ten-year yield fell to +0.55% after oil futures fell to below zero for the first time ever1. Towards the end of the month, news of easing lockdown restrictions and economies reopening led to an increase in yields.
The price of crude oil had a highly volatile month and declined -8.0% - this was on top of the record 54% decline in March. On April 20th, the front month WTI crude oil contract briefly entered negative territory. Low global demand along with economic lockdowns led to the largest inventory build reported by the Energy Information Administration in several years.
Gold prices rose +7.0% as weak economic data along with delicate risk sentiment led the safe haven commodity to rally. At the beginning of the month, the sharp rise in U.S. unemployment claims and fiscal stimulus by the Federal Reserve led gold to reach a multi-year high. Gold ETF demand also reached record levels as investors’ concerns around the impact of the coronavirus continued.
Short-Term Market Outlook
Our proprietary leading economic indicator declined month-over-month and moved further into negative territory. This reading was largely driven by weakness in manufacturing data and a decline in average hours worked.
Our tactical stock-bond model now prefers investment grade bonds versus U.S. stocks. This is driven by weakness in the QS leading economic indicator. 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 expect that high yield will outperform investment grade bonds over the near term, and this reading is at a historic level. The decline in U.S. equity volatility month over month is driving this preference, as it was at an all-time high in March.
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 – compared to a neutral view last month. 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 4/30/20, 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; and U.S. Large Cap Equities represented by the S&P 500 Total Return Index.
1 Source: Reuters.
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.
A Composite PMI gives an overview of the global manufacturing and services sectors.
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.
An exchange traded fund (ETF) is a fund that tracks an index, but can be traded like a stock.
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.
The U.S. Energy Information Administration (EIA) is a principal agency of the U.S. Federal Statistical System responsible for collecting, analyzing, and disseminating energy information to promote sound policymaking, efficient markets, and public understanding of energy and its interaction with the economy and the environment.
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.
West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing. This grade is described as light because of its relatively low density, and sweet because of its low sulfur content. It is the underlying commodity of Chicago Mercantile Exchange's oil futures contracts.
The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.