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Fits And Starts As Re-Opening Turns Into Reclosing

July 2020

After rebounding throughout May, the re-opening trade took a pause in June. Domestic equities chopped during the month, giving and gaining relatively little ground as economic reality sunk in with businesses again forced to shutter in Texas, Florida, and Arizona amid a sharp rise in COVID-19 cases. The S&P 500 managed to eke out a 1.3% monthly gain while the small-cap Russell 2000 outperformed, rising 3.4%. We would characterize market action stateside over the back-half of June as catalyst-light and like the U.S. economy’s re-opening, filled with fits and starts. Economically sensitive sector leadership and the value catch-up trade that occurred in May proved short lived, giving way to the usual growth suspects, i.e. information technology, yet again as June wound down and states announced rollbacks of re-opening plans.

The S&P 500 Growth index outpaced the S&P 500 Value index by 5.7% during the month, with growth’s outperformance more muted farther down the market-cap spectrum as the Russell 2000 Growth surpassed the Russell 2000 Value by just 1.1%. With economic growth uncertain or scarce and visibility murky, investors will likely remain willing to pay a premium for exposure to long-term secular growth leaders. However, economically sensitive sectors will continue to garner interest as ebbing and flowing continues amid progress, real or perceived, toward a COVID-19 vaccine and news tied to the U.S. economy re-opening. A barbell approach between growth and value continues to make sense to us and remains our preferred positioning.

International-developed markets (MSCI EAFE) and emerging markets (MSCI EM) outpaced the S&P 500 and Russell 2000 during June. European equities experienced a renaissance of sorts as the European Central Bank (ECB) increased the size of its bond buying program and pledged additional support via credit facilities, while Germany surprised markets by finally announcing fiscal stimulus measures, with the package exceeding estimates, totaling €130B. Indices tracking market exposure in France, Germany, and Italy rose 2% or more during the month, while the U.K. and Japan lagged after a period of strong relative performance, the U.K.’s FTSE 250 and Japan’s Nikkei 225 lower or higher by less than 1% in June.

On the emerging markets front, leadership was broad, with India, China, South Korea, and Taiwan – the four largest individual country weights and accounting for two-thirds of the MSCI Emerging Markets Index – each rising between 2% and 6%. We continue to question the sustainability of recent relative outperformance from abroad, particularly so in the developing world as COVID-19 cases remain on the rise which could loom large over consumer spending and economic growth. Europe and much of emerging Asia has weathered the worst of the COVID-19 storm and may be poised to experience sharper economic recoveries as a result, and with less demanding valuations versus U.S. stocks the recent rally abroad may be on firmer footing with upside driven by unprecedented fiscal support.

With each passing day we inch closer to November, and market participants will at some point shift their attention away from the benefits of monetary and fiscal stimulus and the rising tide of liquidity that comes with it, and toward preparing portfolios for potential election outcomes. While it’s too early to handicap with any degree of confidence, we would be remiss to not at least consider potential ramifications. Were Joe Biden to win the presidency and the Democratic party take over the Senate, the corporate tax rate may bet set to rise to 28% from 21% at present. An increase of this magnitude could chop around 10% off projected 2021 S&P 500 earnings. Biden would also likely push for the tax rate on capital gains to increase as well, up to around 39% from 15% or 20% at present has been speculated. Should the Senate remain under Republican control, potential changes to the tax code outlined above become far less likely. Conversely, should the probability of Biden becoming president and the Democratic party gaining control of the Senate climb higher as we approach November, investors sitting on substantial long-term capital gains desiring to lower their tax bill in future years may sell, putting downward pressure on stock prices in the process.

While the first half of 2020 was far from dull, the back-half is setting up to be just as intriguing with the U.S. economy experiencing an uneven recovery, U.S./China trade and diplomatic relations on rocky terrain, and the outcome of November’s election looming large for investors. We remain neutral on our target allocation to stocks and bonds, but within equities, we are overweight U.S. stocks relative to our long-term neutral allocation entering July, favoring large-cap (S&P 500) at the expense of international-developed markets (MSCI EAFE). We are more constructive on Europe than we have been in years, and with new stimulus programs in place and cheaper valuations relative to history and U.S. large-caps, the time to get closer to neutral on international-developed markets may be near.

Source: Bloomberg, Factset

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