Equity markets provided a bright spot in a springtime that was, in many ways, a difficult season. With the S&P 500 up 20.0% during the second quarter of 2020, this was the best quarter since Q4 1998 (20.9%). Granted, this stellar performance does come on the heels of Q1 having been the worst quarter since 2008. Quite a bit of the upside is simply a function of stocks having been oversold last quarter and investors realizing that the worst-case scenarios priced in at the bottom were not, in fact, coming to pass.
Qualifiers aside, the numbers were truly stunning. We’ve just passed the three-month time-frame since bouncing off the bottom on March 23, and the market’s performance during that time earns the title of third-highest three-month change in history (as measured by the trailing 65 days).
To be more specific, that’s the third-highest three-month performance since 1954, when the market finally breached the level of 1929’s euphoric highs 25 years later. The only two better performances were the 65 days following market bottoms in 1982 and 2009, which fall into the Rolls Royce category of stock market bottoms.
When we analyze the top ten three-month performances prior to 2020’s post-March bull run, we observe on average a choppy performance over the next month but strong performances over the subsequent three-, six-, and twelve-month periods. In other words, after that initial bounce things tend to be choppy for the next month or so before resuming higher, historically speaking (Figure 1).
Figure 1. Market performance following the top 11 U.S. equity market three-month periods.
Sources: Balentine, FactSet
Given the historical pattern and the seasonal headwinds associated with “sell in May and go away,” we would think the easy money has been made off this bottom. However, though things may be somewhat volatile in the near term, history indicates that patience will reward stock investors over the next year, barring another exogenous shock.
Also worth noting are the similarities between what we’ve been seeing over the past three months and other such periods following bottoms in recent years: 1998, 2002, 2009, 2011, 2016, and 2018. Each of the previous windows also exhibited a pronounced out-performance in stocks characterized by small capitalization, lower quality, and higher beta, as well as those that had been heavily shorted.
Boom times for large caps
This was the second-best quarter ever for U.S. Large Cap Growth stocks, our largest holding, since we began tracking the data in 1979. Like the overall S&P, this category’s performance over the most recent quarter trailed only the fourth quarter of 1998 (U.S. Large Cap +26.7%). And in an interesting parallel to today’s pattern, the preceding quarter to 4Q98 had its own crisis: the Russian financial crisis that was sparked by the Asian financial crisis which had begun a year earlier.
Large Cap Growth continues to strongly outperform Large Cap Value in the second quarter, marking the sixth consecutive quarter of Growth out-performance. It’s not just a handful of extraordinary performers driving this charge, either. Let us dismiss the popular but inaccurate notion that this dramatic exhibition of strength has been all about FANMAG (i.e., Facebook, Apple, Netflix, Microsoft, Amazon, and Google—an acronym that seems to grow longer every week!). The market cap index is making all-time highs, yes, but the equal weight index is repeatedly hitting new highs as well. So, although the big players will continue to make the most significant impact on the index, this standout market performance is by no means narrow or limited to just the biggest technology players.
A bright future for gold and international equities
Gold continues to perform admirably, standing out even as equities rise. Our model highlights a longer-term upward trend (Figure 2), with gold breaking through $1,800 on June 30 for the first time in almost nine years.
Figure 2. Gold market performance from June 2010 to June 2020.
Sources: Balentine, FactSet
The last time it accomplished the feat, a quick spike to a little above $1,900 preceded an immediate drop back under the $1,800 threshold. Consolidating over the next year at levels between $1,525 and $1,825 and failing three prior times to breach $1,800, gold then endured a precipitous bear market that persisted for over three years (from October 2012 until December of 2015), causing a brutal 42% drop and culminating in a trough at $1,045.
After basing and consolidating for six or seven years, gold initially broke out in June of 2019 and has climbed further during the first half of 2020. Our model remains very constructive on gold; we remain optimistic both technically, as just described, and fundamentally, on the back of the massive monetary stimulus from the Federal Reserve and other global central banks.
International equities also had a very good month relative to U.S. stocks. EAFE and Emerging Markets gained 3.4% and 7.4%, respectively, compared to 2.2% for the Russell 1000. Of course, overall market trends have been strongly against international equities for some years now, and in that context, one strong month does not a new trend make. But international equities are far more compellingly valued than U.S. assets at the moment, and at some point, this valuation disparity will matter. When that time comes, and market performance confirms the resulting trend shift rather than merely hinting at it, we will not hesitate to expand the borders of our portfolio.
Biding our time behind the wall
As always, we continue to listen closely to the message of the markets, attuned to relative value and momentum indicators, and mindful that there is reason for investors to maintain relatively cautious expectations for now, based on current signals. Our opinion is that the economy has likely bottomed, but the path back up is likely to be a slog.
While the market remains strong overall, its position is far from uniform. We’ve seen sharp corrections in many industry groups and less dramatic pullbacks in others since the June apex (Figure 3).
Figure 3. Change in value since June highs for various equity categories.
Although it seems like a lot of money has gone into stocks since the March 23 bottom, the reality is that over three times as much has gone into bonds—an obvious flight to safety by investors. Much of this money has remained in bonds, which means there is a wall of liquidity waiting to flow back to equities when fears of the virus and its economic impact abate.
As the old saying goes, markets climb a wall of worry; the wall of worry that investors built during February and March remains high, thus persisting as a likely tailwind for the market as seasonality becomes more market-friendly. But again, prudence demands patience to get through the period of summer volatility and allow certain market leaders room for continued consolidation.
Moving forward, three key indicators can help investors monitor the viability of the current rally:
Corporate credit spreads. While these have ticked a little higher, so far spreads have remained within a reasonable range and avoided the highs we saw in March.
Performance in weaker areas of the market. The areas most affected by COVID-19 include small cap, financials, energy, and consumer discretionary stocks, among others. These sectors continue to post solid gains but are running into resistance that may prove more daunting than anything they encountered in their original bounce off the bottom. The good news is that a successful push past these resistance levels should lend formidable strength to the overall market’s forward momentum.
Bond yields. Yield remains low, especially on the shorter end of the yield curve. If we’re looking for omens of sustainable progress moving forward, we are going to need to see yields rise somewhat.