While the weather has improved and the dog days of summer are upon us, global markets have not calmed down at all. July and August are typically months which have low trading volumes and limited volatility; yet 2020 is once again proving to be anything but dull.
As many countries around the globe appear to be making progress on the pandemic and getting back on the path to the new normal, the US has botched its response and has had to pause or roll back some of the reopening plans. This has weighed on sectors of the market that had begun to show strength earlier in the spring and seemingly delayed the long-awaited rotation from growth to value. The FAANG stocks are still the leadership group. Makes one wonder how long can it last?
We have begun to see second quarter earnings over the last few weeks and most companies have shown results which met or exceeded expectations. However, the fact many companies did not give guidance means these reports have been an analyst’s worst nightmare, making it very difficult to come up with estimates. As a result, most expectations were conservative and easily beaten. What has been interesting is that in a number of cases the good news of these beats has been met with selling pressure. For the few winners (mostly large-cap tech), this could be the case that everyone already owns them and there is no one left to buy.
One of the many victims of the virus now appears to be the US dollar, as it seems to be at risk of losing its safe-haven status. For many years, in times of distress, investors around the world would move assets into US treasuries or dollar-based investments until the smoke cleared. Over the last few months, those strategies appear to be changing and the days of “King Dollar” may be numbered.
Whether this is due to how the virus was handled, the breakdown in China relations or the ongoing stress around the US election, the fact remains the dollar has had an awful stretch. The DXY Index (which is the US dollar versus a basket of foreign currencies) declined over 4% for the month of July and is down over 10% from the peak in March. When assets of this scale move this quickly, it’s time to take notice.
With the weakness in the greenback, one of the main beneficiaries has been gold. The precious metals have had a few of their best months in years. Gold hit a new all-time high and getting close to the $2000 level. Silver, which had lagged gold for most of the year, was up an amazing 30% on the month. Gold miners also benefited, joining technology to lead the overall market higher.
The turnaround in operations at many of the gold miners has been stunning as most had setup to run profitably at $1200 gold and $60 oil. Higher gold and lower oil prices go straight to the bottom line. The seasonality for gold is usually very strong throughout Q3 and it could be setting up for a historic run here with many analysts targeting $2200 by the end of the year.
The dramatic move in precious metals has begun to start the conversation about the possibility of a return of inflation. One of the worst-case scenarios economists worry about is a jump in inflation at a time when economic growth is anemic. This is referred to as stagflation. It can be measured by real rates, which is the US 10-year Treasury yield minus the five-year expectation of inflation. This measure closed the month at an all-time low of -1%.
Real rates have a near-perfect inverse correlation to gold/silver. Strength in those commodities signals the market is expecting this pattern to persist. It’s hard to believe inflation would occur in an environment of such high unemployment, but historic government stimulus spending combined with a changing global supply chain is rewriting the rules.
While overall market benchmarks have had an amazing run in the last few months, without the broader participation of all groups, including the banks, it’s hard to feel great about it. Lots has been written about how narrow this market is as everyone has been piling into the few winning sectors and themes.
The rise in speculative day trading and SPACs has many wondering about the risk we are getting close to a repeat of 2000? The big difference this time is that many of these winning companies are hugely profitable with strong balance sheets. They’re not simply concept stocks. A pause in some of the leaders and an increase in money flow to other areas could go a long way to helping prolong this bounce.
The next few months should continue the trend of higher volatility we have become used to this year. There will be the typical debates around the next fiscal stimulus programs, along with the fears of a second wave of the virus and how school openings will work. But the biggest event to shift attention is going to be the US election. Like it or not, US politics affects asset valuations around the globe. With three months to go before the election and an uncertain path forward, polls and policy announcements will increase this volatility. By the time we get to Labour Day, this should be the main story.
July was by many measures a good month for markets. Maybe having professional sports return will provide some relief and a sense of normalcy, but 2020 has proven to be anything but a normal year and the month of August has a history of surprising investors. It may be time to lock in some gains in the winners and prepare for some bumps in the road. The lack of yield in the bond market has left equities as one of the only games in town for income-starved investors. We do think there is a chance the amount of proactive measures by central banks and governments may get us through this, but there is no way this will be a smooth ride.
— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments
All data sourced from Bloomberg unless otherwise noted.
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