June 30, 2020

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Market Commentary
The stock market is said to trade based on  “forward looking indicators,” not on historical valuation metrics. That has likely never been more true than during the rampant rally that we experienced in the second quarter of 2020.  Despite historically high unemployment, huge drops in economic activity, and ongoing uncertainty about how and when aspects of the economy will resume from the COVID lockdowns, investors looked forward to possibly brighter days and stocks rallied with a 20% quarterly gain for the S&P 500 index.  A similar resurgence impacted Mid/Small Cap stocks and Foreign stocks, with double-digit gains being common in many broad stock indexes.

After dropping over 33% from the peak in February to the lows of late March, the S&P index gained back a huge part of that loss in the late first quarter and most of the second quarter before easing up in later June to finish with that 20% gain.  We are still below the all-time highs from February, but the rally provided the largest 50-day gain in modern market history.  The VIX volatility index (the “fear gauge”) had climbed to an all-time high on March 16^th, then dropped over 70% from that high mark before rising back up moderately in mid- to late-June on concerns about virus case resurgence.  Oil had another wild quarter, with prices temporarily going negative for specific contracts on oversupply issues, then rallying back to end the quarter at around $40 per barrel.

The Fed has continued to lead an accommodative path, with the Fed Fund rate likely to stay at or near 0% and the Fed commitment to be a bond buyer to keep liquidity high in that marketplace.  Treasury rates have stayed very low, with 10-year yields in the 0.60% to 0.70% range as investors both domestic and abroad continue to view that instrument as a safe haven.  Corporate bonds and High Yield bonds each provided upside for the quarter with that increased appetite for risk, though volatility for each of those bond types has increased beyond typical levels.  Treasuries had a muted quarter following outsized price increases in the panic of the previous period, but they did manage to eke out small gains.

As we look ahead, attention will likely remain hyper-focused on COVID case levels and the impact that rising or falling cases may have on the economy- and particularly on consumer sentiment.  Consumers drive over 2/3rds of our economic activity, so both the ability and the willingness to resume our typical purchasing will be a huge indicator of how the recovery out of this COVID period plays out.  This is also of course tied to the work on treatments/vaccines, and the willingness of citizens to follow protocols intended to help mitigate the spread as much as possible.  The market has priced in a rapid economic recovery, so news perceived as negative can have a sharp impact on values.
We have identified key data points in recent market commentaries. While these metrics will appear quite displaced now from typical readings, here is where they stand:

• Valuations. Valuations dropped to about 15.5x existing earnings in late Q1, but given the sharp drop in economic activity in late Q1 and all of Q2, current forward P/E ratios are estimated at around 21.5x earnings (source: JPMorgan).  This is quite high, even relative to meager Treasury yields, so going forward much attention will be placed on when earnings can catch up to prices.  

 

• Economic growth. Most recent estimates by the Atlanta Fed predict Q2 at an astounding             -35%. Expectations are that Q3 should be better- but how much better?  Broad consensus is for a recovery to begin during this quarter, but there are many variables to overcome.

 

• Interest rates. The Federal Open Markets Committee cut rates to essentially 0%, and have committed to stay there as long as necessary.  10-year Treasury rates have hovered around 0.6% to 0.7%, and while the yield curve has normalized that can change if sentiment shifts down.

 

• Currency. The USD has continued to mildly weaken relative to other major currencies, and this has helped boost returns for non-U.S. based securities.  The trend of dollar leadership had lasted almost a decade, and the projected shift away from dollar strength is modestly playing out.

Portfolio Positioning
The temptation to sell in late March and feel the relief of not seeing more red numbers was likely strong, but our conviction to remain invested- and seek out chances to make buys when applicable- has helped clients regain significant value.  The bond classes continue to provide downside protection and some recurring income, and we are looking at possibly extending duration as rates stay low for the foreseeable future. And while Growth style stocks have led returns, our Equity Income strategy has had strong returns relative to Value benchmarks year-to-date and remains competitive with the broad S&P 500 with less historic volatility. 

Asset Class Review
The second quarter saw strong returns across all broad stock indexes.  The period also provided large gains for corporate and high yield bonds, while Treasuries had modest gains.  Broad commodities were positive for the quarter based largely on gold reaching $1800 per ounce, which helped counter relative weakness in oil and other commodity components.
Every sector of the S&P 500 was positive, with gains led by the beleaguered Energy sector, followed by the strong Consumer Discretionary and Tech sectors.  The weakest gains were in Utilities at about 2%, but all other sectors gained at least 8% for the quarter.  Mid Cap and Small Cap stocks gained even more than Large Cap for the quarter, but still lag well behind big stocks so far this year.   

Bonds provided strong upside after a mixed first quarter, with Corporates and High Yield each rallying up over 8% after weak first quarters. The Bloomberg Barclays Aggregate bond index gained 3% in the period, same as the previous quarter, but this time Treasuries (as opposed to lower credit quality bonds) were the drag on that index return. 
Foreign stocks had a very strong rally, with the MSCI EAFE index gaining over 15% and the MSCI Emerging Markets index gaining over 17%.  These classes continue to be cheap by both absolute and relative to domestic stock standards, and we continue to see upside potential here.  However, as noted in previous reviews, it will require patience to see that upside as the world works through these current issues together.

Past performance is not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be profitable or suitable for a particular investor's financial situation or risk tolerance. You cannot invest directly in an index. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses. Source: Morningstar

All opinions and data included in this commentary are as of June 30, 2020 and are subject to change.  The opinions and views expressed herein are of Cutler Investment Counsel, LLC and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This report is provided for informational purposes only and should not be considered a recommendation or solicitation to purchase securities. This information should not be used as the sole basis to make any investment decision.  The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed.  Neither Cutler Investment Counsel, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.