The Fed shifts on inflation – What does it mean?
The Fed unveiled a revision to its monetary policy, allowing for higher inflation to help support the labor market. We believe this action could keep interest rates low for years.
Dan Hanson: We have been closely watching earnings season, which is nearing its end with over 90% of S&P 500 and large cap companies reporting. Retailers have a busy week this week as they report results from the quarter ending April 30. Companies like Walmart, Home Depot, and Target all report, providing some timely and interesting insight into economic health and activity, as well as forward looking guidance.
We continue to see market volatility consistent with elevated uncertainty investors still face. Amidst the volatility, some companies have fared much better than others, in what could be characterized as a market of haves and have-nots. Growth stalwarts, for example, have strong performance trends. After losing nearly a third of its value from the February peak to March 23 lows, the Russell 1000 Growth index has recovered about 33%. That large-cap growth index is essentially flat year-to-date (YTD), and has returned about 15% over the last year. Many of the work-from-home themes support these growth-oriented companies, helping them not just survive, but actually thrive with some reporting double-digit sales growth.
By contrast, some of the more cyclical parts of the market continue to be challenged. Small-cap value companies as represented by the Russell 2000 Value index are down 35% YTD and nearly 30% year-over-year. Another way to view these “haves and have nots” is by comparing the market-cap weighted index to an equal-weighted version of the same index. The market-cap weighted S&P 500 Index is down about 11% YTD, but positive by about 2.5% over the last year. The equal-weighted version of the S&P 500 Index is down just over 20% for the year, and a little over 10% year-over-year. This again illustrates leadership from the biggest companies in our country. In our view, this is rational behavior. Businesses generating revenue growth are doing well. Conversely, cyclical, asset-intensive industries like autos, oil and gas, hotels and leisure have seen earnings drop to zero.
Source: FactSet, Ivy Investments. Data show year-over-year performance of the S&P 500 Index versus the S&P 500 Equal Weighted Index. Past performance is not a guarantee of future results.
A final observation: the price of safety seems quite elevated. This seems clear by looking at the U.S. Treasury market. On a total return basis, the 10-year U.S. Treasury has returned nearly 13% and the 30-year with its added duration is up 27%. Yields are still quite thin, too. The 10-year Treasury bond yield is still well below 1% at 70 basis points and the 30-year Treasury yield is near 1.4%. Considering the Federal Reserve’s inflation target of 2%, negative real returns seem likely over the long-term. Active equity investors, in our view, can take advantage of this extreme risk aversion by finding attractive opportunities supported by strong fundamentals.
Derek Hamilton: Recent data continue to point to April as the bottom in activity for most of the world. Starting with China, last week’s data show an uneven but progressing recovery in activity. Keep in mind, China was two months ahead of the U.S., both in terms of the shutdown and reopening. The industrial part of their economy is operating at near-normal levels, while consumption and services lag. Infrastructure is snapping back very quickly. In addition, we believe there could be underlying weakness in China’s labor market that may not be visible in the statistics. The export sector is struggling, and additional stimulus will likely be the primary focus of policymakers. China’s communist party begins an important meeting later this week and we could start to see signals of more action during that time.
However, the news out of China is not all positive. Tensions between the U.S. and China are starting to reaccelerate, with the U.S. putting more pressure on China in the form of new export rules around technology. TSMC, a prominent Taiwanese semiconductor manufacturer with some manufacturing facilities in China, announced its intention to build a new plant in Arizona. As part of the negotiations, the U.S. may ask the company to cease supplying chips to Huawei, a company identified as a cyber-threat by U.S. officials. As this year’s elections near, we should expect the main presidential contenders, as well as down-ballot campaigns, to ratchet up the rhetoric on China, casting the country as a villain.
Regarding data around COVID-19, most of the world continues to point to further improvement with curves broadly coming down, which is very encouraging. Mobility data from Google and Apple also shows improvement. The information from Google shows retail and recreation continuing to recover. This activity had fallen 45% from pre-virus levels, and it is now down 30%. Similar trends are visible in Germany, and we are starting to see improvement in the rest of Europe as well. Data from Apple Maps shows the number of requests for different destinations in the U.S. is now positive compared to January, meaning Americans are responding to the reopening of our economy.
Businesses that are open are quite busy although regions of the country are re-opening at different paces. We'll likely see an uneven recovery as a result. Even though the economy seems to be improving, companies may initially bring back fewer employees than expected. It is important to remember that municipalities are still placing restrictions on the number of people visiting reopened businesses. Restaurants may appear to be full, but are required to reduce the number of tables served to maintain social distancing. In addition, we recognize small businesses are under immense pressure and that some of these jobs will disappear as companies close their doors for good. While we do believe the unemployment rate will fall in the near-term, we think it will remain high relative to rates prior to the pandemic.
Past performance is not a guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through May 11, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
The S&P 500 Index is a float-adjusted market capitalization weighted index that measures the large-capitalization U.S. equity market. The S&P 500® Equal Weight Index (EWI) is the equal-weight version of the S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight - or 0.2% of the index total at each quarterly rebalance. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. The Russell 2000 Value Index is a float-adjusted market capitalization weighted index that measures the performance of the small-cap value segment of the U.S. equity universe. It is not possible to invest directly in an index.
Risk factors: Investing involves risk and the potential to lose principal. Fixed-income securities are subject to interest rate risk and, as such, the value of such securities may fall as interest rates rise. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.