When our Asset Allocation Committee met recently, it was faced with a string of robust prints for some of the more fast-moving and forward-looking releases on the economic data calendar. These hinted at a strength quite at odds with our base case for a prolonged, U-shaped recession following the COVID-19 crisis.
Details of how we reconciled these data with our medium-term asset allocation views will follow in our forthcoming quarterly AAC Outlook, but first: Were we wrong to be so cautious three months ago? Is a V-shaped economic recovery about to consolidate a V-shaped equity market rally?
Over recent weeks, we’ve been saying that the V-shaped equity market is deceptive. Far from a vote of confidence, the rally has been led by a handful of defensive, U.S. large-cap growth stocks, and it has not been backed up by a similar rebound in more economically sensitive sectors and regions or in Treasury yields.
That reflected the enormous contraction in global economic activity since the COVID-19 pandemic took hold, we argued—not to mention the fact that many of the risks that could threaten an L-shaped recession are still live. Economists’ expectations for second-quarter GDP growth are still bad enough to align with the U-shaped scenario we set out at the beginning of April, rather than our more optimistic V-shaped scenario.
But then, instead of losing eight million non-farm jobs in May as expected, the U.S. created 2.5 million. U.S. retail sales jumped by a record 18% in the same month, more than double what had been forecast. New U.S. home sales in May raced ahead of expectations, as did the NAHB Housing Market Index of homebuilder sentiment. Last week, a slew of Purchasing Managers’ Index (PMI) releases showed activity picking up faster than anticipated, worldwide and across both manufacturing and services.
The Citigroup Economic Surprise Index, which is designed to identify momentum in these data, has leapt to record highs of 150-plus after slumping to -140 two months ago.
While some of the headline growth numbers have been remarkable, it is important not to be misled by low-base effects or to confuse a strong recovery with a full one.
Two and a half million jobs in the U.S. is great news, but we need almost 10 times that to get back to the unemployment levels of four months ago. PMIs have rebounded, but most indicate that activity is still contracting, not expanding—even new orders. Housing market sentiment has only recovered to end-of-2018 levels.
Similarly, the current boost suggests that employers are rehiring before government furlough payments come to an end, that three months spent sitting at home has left many consumers with a large pile of savings, and that businesses are pushing to restock inventories to meet pent-up demand.
Once the new equilibrium is established, however, it is highly unlikely to be at the same level as January 2020. The pre-crisis conditions of low growth, low interest rates, low productivity and high debt are likely to be compounded by even higher debt, even lower rates, higher taxes, tighter regulation, lower consumer confidence, ongoing social distancing and travel restrictions, and, potentially, a steep cliff edge on the other side of the current fiscal stimulus.
And remember, that is a base-case scenario in which the recent, worrying increase in COVID-19 cases and rising U.S.-China tensions turn out to be false alarms.
What does this mean for asset allocation?
We still think there’s a case for tilting toward more risk, on a medium-term view. The economy is recovering, if not as rapidly as the more fast-moving and survey-based data might suggest, supported by abundant liquidity from central banks and fiscal stimuli.
Institutional investor positioning remains notably conservative. The equity market rally has only just started to broaden out beyond the U.S. growth giants, so this is not an out-of-control bull market. Given the scale of the stimulus and the shoring up of household and corporate balance sheets, our estimate of the floor for the S&P 500 in the event of an L-shaped outcome is higher now than it was three months ago.
Nonetheless, given the ongoing level of uncertainty, we retain a bias to quality. With some asset classes now apparently fully valued for a U- or even V-shaped recovery, and with the exceptional disconnect between the bounce-back of recent weeks and the hard struggle of the coming months, we recognize that medium-term views will likely be more than usually subordinated to tactical positioning.
Look out for more detail in our forthcoming Outlook. In the meantime, take care not to be fooled by low-base effects or mistake a strong recovery for a full one.
In Case You Missed It
- U.S. Existing Home Sales: -9.7% to SAAR of 3.91 million units in May
- Japan Purchasing Managers’ Index: -0.6 to 37.8 in June (Flash)
- Eurozone Purchasing Managers’ Index: +7.5 to 46.9 in June (Flash)
- U.S. Purchasing Managers’ Index: +9.8 to 46.8 in June (Flash)
- U.S. New Home Sales: +16.6% to SAAR of 676,000 units in May
- U.S. Initial Jobless Claims: +1.48 million in the week ending June 20
- U.S. Durable Goods Orders: +15.8% in May (excluding transportation, durable goods orders +4.0%)
- U.S. 1Q 2020 (Final): -5.0% QoQ annualized rate
- U.S. Personal Income and Outlays: Personal spending increased 8.2%, income decreased 4.2%, and the savings rate increased to 23.2% in May
What to Watch For
- Monday, June 29:
- China Purchasing Managers’ Index
- Tuesday, June 30:
- Eurozone Consumer Price Index
- S&P Case-Shiller Home Price Index
- U.S. Consumer Confidence
- Wednesday, July 1:
- ISM Manufacturing Index
- FOMC Minutes
- Thursday, July 2:
- U.S. Employment Report
Statistics on the Current State of the Market – as of June 26, 2020
|S&P 500 Index||-2.9%||-1.0%||-6.0%|
|Russell 1000 Index||-2.8%||-0.8%||-5.7%|
|Russell 1000 Growth Index||-1.9%||1.3%||6.6%|
|Russell 1000 Value Index||-4.2%||-3.6%||-18.8%|
|Russell 2000 Index||-2.8%||-1.0%||-16.8%|
|MSCI World Index||-2.3%||0.6%||-7.4%|
|MSCI EAFE Index||-1.3%||3.3%||-11.2%|
|MSCI Emerging Markets Index||-0.1%||7.7%||-9.4%|
|STOXX Europe 600||-1.7%||3.2%||-12.8%|
|FTSE 100 Index||-2.1%||1.5%||-17.0%|
|CSI 300 Index||1.2%||7.7%||2.0%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.0%||0.0%||2.9%|
|Citigroup 10-Year Treasury Index||0.6%||0.1%||12.6%|
|Bloomberg Barclays Municipal Bond Index||0.1%||0.8%||2.0%|
|Bloomberg Barclays US Aggregate Bond Index||0.2%||0.6%||6.1%|
|Bloomberg Barclays Global Aggregate Index||0.2%||0.9%||3.0%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-1.5%||0.2%||-3.6%|
|ICE BofAML U.S. High Yield Index||-1.3%||1.3%||-4.4%|
|ICE BofAML Global High Yield Index||-0.8%||2.1%||-4.1%|
|JP Morgan EMBI Global Diversified Index||0.1%||3.5%||-2.8%|
|JP Morgan GBI-EM Global Diversified Index||-0.5%||0.6%||-6.8%|
|U.S. Dollar per British Pounds||-0.4%||-0.4%||-7.0%|
|U.S. Dollar per Euro||0.2%||0.7%||-0.2%|
|U.S. Dollar per Japanese Yen||-0.3%||0.4%||1.2%|
|Real & Alternative Assets|
|Alerian MLP Index||-10.5%||-9.5%||-36.8%|
|FTSE EPRA/NAREIT North America Index||-3.3%||0.5%||-23.2%|
|FTSE EPRA/NAREIT Global Index||-2.8%||2.1%||-21.9%|
|Bloomberg Commodity Index||-2.1%||-0.5%||-21.6%|
|Gold (NYM $/ozt) Continuous Future||1.6%||1.6%||16.9%|
|Crude Oil WTI (NYM $/bbl) Continuous Future||-3.2%||8.5%||-37.0%|
Source: FactSet, Neuberger Berman.