 Economic Highlights
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The COVID-19 outbreak has slowed down in Northeast US and some parts of the globe, while it’s peaking in Latin America and Middle East, and it’s reappearing in Southern US states and China.
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The headline economic numbers are still terrible, but the May payroll number was a huge upside surprise, to the tune of 10 million more jobs than economist expected. Overall, over 45 million jobless claims have been filed since the beginning of the lockdowns.
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Consumer Spending unsurprisingly dropped sharply, but the personal savings rate increased substantially. Core inflation also dropped.
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The Congress is discussing more stimulus, while the Fed has expanded its liquidity program to buying individual corporate bonds.
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Massive nationwide and now international protests against racial discrimination and police brutality threaten a new wave of virus spread as well as to kill the nascent economic reopening.
 Market Highlights
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US Equities continued their recovery, with S&P 500 Index closing higher by 4.8%.
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Foreign equities also rallied, with Developed Markets up by 4.4%, and Emerging Markets were mixed with vastly different virus situations, overall up 0.8%.
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US high-grade bonds added 0.5%, while high yield jumped 4.4%, and foreign high yield posted a similar 4.1% gain.
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Commodities had the biggest rebound, up 11.2%, led by monstrous rebound of oil from multi-year lows, up 87.5%. Gold added another 2.6%.
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US Dollar was the only major asset in the red for the month, down -0.7%, with further expectations of weakness.
 Observations and Expectations
May has been a month of continuing rebound in equities led by the small caps and other risky assets such as high yield bonds and commodities. Oil has exemplified the rise, going from briefly negative values to the upper $30s in a few short weeks. The rally is in full-on mode, with many industries, individual stocks and even broader indexes approaching and hitting new all-time highs. Does that make sense? How does the current state of economy correlate with the market?
More on that in our Question of the Month. For now, let’s just say that this author has been one of the few optimists in late March that expected a sharp rebound in the market. But even I was surprised by the sheer strength, speed and breadth of the gains. Especially considering a big list of giant risks facing the markets today, from the virus second wave, to the civil unrest, possible insufficient economic stimulus, upcoming US elections, flared up trade dispute with China, and much more. Markets don’t move in a straight line for too long, up or down. The “easy” money may have already been made. If no consolidation in the markets happens soon, we may be in for a new “risk off” cycle very soon.
Looking forward to June, we expect to see the test of the bull theory that reopening of the economy brings back jobs and consumer spending. It will realistically be months before this could be fully ascertained, unless the setback is obvious. We still expect a number of themes to significantly outperform the market, mostly in technology, especially in the long run. Even as Buffett infamously sold airline stocks in April, and they have rallied hard since, we still stay away from many portions of the beaten down Travel and Leisure industry. Gold and Treasuries remain the best hedges for the foreseeable future.
 Sector Update
Financials remain the second worst-performing sector of the 11 S&P sectors so far this year, behind only the abysmal performance of Energy. A few months back we pointed out that the selloff was largely overdone, and the sector rebounded with the rest of the market. However, the pop appears to be over now. Questions remain about the health of the banks’ underlying loan portfolios, including business loans, mortgages, auto and student loans. Any meaningful change in the perceived or actual delinquency rate could significantly impact the entire sector.
Consumer Discretionary sector was one of the hardest hit by the shutdown of the economy. While the demand for leisure products has cratered, revenues in many services in hospitality and entertainment industries just suddenly went to zero. With the economy reopening, companies in this sector are trying to capture the pent-up consumer demand to survive and get back to former glory. Our prediction is that those with strongest balance sheets will come out big winners.
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 Question of the Month
This is where we answer the best investment question we’ve heard all month. If you’d like your question to be considered, please send it to us.
Question
Is there a disconnect between a massive market rally and the state of current economy?
Answer
To use the same word again, this year has been unprecedented, and it’s not even halfway through. And the markets have matched the current events on that front. With the lack of transparency into the medical, political and economic situation over the past months, many economists and market “experts” made a case for further market weakness. Even after the expected relief rally following the announcement of the giant stimulus package, the prevalent opinion on the future direction remained to the downside. Yet stocks have gone nowhere but up. So, what’s driving them and what can we expect in the near future?
We already touched on some of the forces driving the decision of market participants in this section two months ago. To summarize, the movements are largely based on future expectations, prices are relative to similar assets and to past prices.
So, let’s take a look at some of the positive factors, verified and assumed, that are driving up the markets:
The optimism of the virus spread subsiding, economy reopening and economic stimulus working – largely priced in at this point. The IPO market has come back to life, with many well-received new issues and lots in the pipeline. Many investors have cash on the sidelines or in low-yielding bonds that would need to reallocate to equities in the future. Many professional money managers who have lagged the market and are trying to catch up. Many younger, newer investors jumping into the market over the past couple of months.
That last point requires further explanation. As the lockdown forced many young people to unemployment and/or studying from home, several important changes happened. They suddenly had more time and less social activity. Even the usual sports watching, betting and sports fantasy so popular with the younger millennials suddenly disappeared. Add to that many zero-commission trading apps like Robinhood with very low margin rates, and you have what some call the “fun casino” theory. The do-it-yourself generation saw the opportunity to make money day trading, with instant gratification included. Under the “fun casino” theory, buyers are interested in speculative opportunities rather than seeking fundamental long-term investing. It would explain elevated small caps trading, option trading activity and especially the exuberance in buying bankruptcy stocks. Hertz is the latest example where the stock tripled AFTER announcing filing for bankruptcy. The company even tried to capitalize on this by offering more shares to the public, which the prospectus said should be expected to lose its full value! Unprecedented doesn’t even begin to describe it, and the bankruptcy judge ultimately nixed the idea. Still, if this group is really responsible for a portion of the stock market gains, it’s ben great, but future buyers beware!
On the negative part of the equation, many factors are stacking up against the market:
Huge risks remain as we mentioned. If things turn sour, the herd mentality may trample anyone trying to get out at the wrong time. Low margin rates may have caused larger margin accounts in some cases, which will always hurt more on the way down. A significant downward move this time could kill the confidence for the long-term investors and keep the markets down for longer this time.
In conclusion, there are still forces to pull the market higher as well as lower at play today. Both risks and opportunities remain with significant dislocations. Investors should know their risks and objectives and stick to the plan, now more than ever.
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