May 5, 2020
After the sharpest decline from a record high to a bear market, stocks continued to roar back in April. Stocks posted their best monthly return since 1987. Similarly, credit markets, which we discussed as an opportunity last month, posted strong gains.

At first glance, the robust capital gains seem divorced from the dismal economic trends and headlines of the past month. The US economy reported its weakest quarter of growth since the financial crisis, and the outlook for the second quarter is expected to be the worst since quarterly data became available in 1947. Offsetting this unprecedented shock to the economy is a fiscal and monetary response that has been equally unprecedented in the size and speed of its implementation. The 2008 financial crisis, still so fresh in everyone’s mind, is a positive insofar as the experience undoubtedly contributed to the swiftness of the government’s response. Markets were also buoyed by tentative signs that the coronavirus infection curve is showing signs of flattening and optimism surrounding new therapeutic treatments.

From an economic perspective, this could be perhaps one of the sharpest but also one of the shortest recessions in US history. Given stocks have bottomed five months prior to the end of recessions, on average, the market is now pricing in an increased likelihood that economic activity begins to improve, albeit from a very depressed level, sometime during the summer. The next test will be the gradual reopening of the economy, and this is likely to be uneven and met with fits and starts for both the economy and markets.

After the very favorable risk/reward environment we discussed near the market lows, we view the current short-term outlook as more mixed. Still, we see better relative value in stocks on a longer-term basis. Accordingly, we favor an averaging-in approach for investors underweight equities and becoming more aggressive on pullbacks. For investors who contemplated selling at the recent low, now that the market has seen a rebound, this is also a good time to revisit asset allocations to ensure consistency with goals and risk tolerance.

From a portfolio perspective we see the US as best positioned to navigate the current uncertainty. International markets remain cheap but are in a fragile position given weaker economic trends and a less coordinated response. The backlash against China’s handling of the coronavirus outbreak is growing and gaining traction not only in the US but in Europe as well, and we have become incrementally more negative on emerging markets. Interest rates are set to stay low in the near term, and we maintain an up-in-quality focus within fixed income. The opportunity in credit has diminished, but we still see some relative opportunity in investment grade and high yield corporate bonds for investors with a higher risk tolerance.

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