By: Stash Graham
The stock market’s rise from the March lows slowed down notably during June as market participants received a confusing mix of economic data to digest while also observing a rise of COVID-19 cases nationwide. Traditional haven investments, like the 10-year U.S. Treasury and Gold, performed well in a month that saw an increase in volatility across all asset classes. Our gold exposure was up almost +3% on the month outperforming the S&P 500 (+1.8%) and Dow Jones Industrial Average (+1.7%), while our U.S. Treasury 10-year bond proxy was up +0.8%. The second Thursday of June (June 11th) stood out as a prime example of this increased volatility as we saw a broad-based move lower in all three major indexes by more than 6% in the single trading day. Gold’s outperformance this year continued as the price of the precious metal reached $1,800 per ounce for the first time since 2011. Monetary and fiscal developments from the Federal Reserve and U.S. Government, respectively, have provided a tailwind for the haven precious metal to move higher.
In the near term, the plan of action at the firm is to continue monitoring commodity prices as they have performed well across the board this month. Supply disruptions continue to linger. Our broad-based commodity ETF, Invesco Optimum Yield Diversified Commodity, has started well since our initiation. Furthermore, we have witnessed weakness in the regulated utility sector over the last three weeks. This is an industry that we have performed a significant amount of due diligence on over the last few months. It is one of a few dividend-paying sectors that were down more than -5% this past month; as a result, some value might be forming. We will be acting very soon here. Lastly, we are monitoring a basket of special situation opportunities involving arbitrage, liquidation, and fixed income. Opportunities that we hope to share with you in the near future.
The economic recovery continues to be mixed. Opportunity Insights, a Harvard University-based research group, produced a mid-month report detailing how high-income individuals have decreased their consumption significantly since early March. According to the report, as of June 9th, the top 25% of income earners have been responsible for 53% of aggregate spending decline. Meanwhile, the earners at the other end of the income spectrum (i.e., the bottom 25% of income earners) have shown a willingness to spend. The historic amount of fiscal spending from Capitol Hill has produced newly found cash for people in this income bracket. The major issue is that high-income earners spend a significant amount of their consumption on discretionary service-related goods. If this income demographic feels unsafe venturing out due to the COVID-19 outbreak, they will not spend nearly as much as needed. The stubbornly slow decline in initial jobless claims validates these concerns. If the virus continues to spread, it does not matter whether a state officially forces a shutdown or not—the high-income earners will not spend enough to generate a sustainable amount of revenue.
This month we saw the first changes in state leadership decision-making related to COVID-19. Texas Governor Greg Abbott announced a peeling back from the reopening phase process as his state is dealing with a material increase in the amount of the Texas residents infected with the virus. An example of the difficulties in Texas is the Texas Medical Center. The Houston-based medical system (one of the largest health destinations in the world) changed their ICU capacity data which drew scrutiny from local government officials, who were saying that they based their policy related decision-making based on the data provided by the medical system. The thought was if the ICU capacity data has been incorrect since March then local officials were possibly making incorrect policy decisions. Then a few days ago, Texas Medical Center withdrew their ICU data entirely. Unfortunately, we are witnessing broad increases in positive COVID-19 cases and, and more importantly, hospitalizations. In response, Governor Abbott has now paired back the state “reopening” and has made an Executive Order halting elective surgeries in eight of the most populous counties in Texas to assure that there are enough beds to treat suspected COVID-19 cases. We are concerned that similar developments are happening in California and Florida. In Florida, Governor Ron DeSantis announced that Florida would start to report current COVID-19 hospitalization rates after seeing a surge in the COVID-19 cases.
The Wall Street Journal had an interesting front-page article at the end of the month titled “Banks Left to Guess on Credit Decisions”. The article details one of the major issues facing a bank’s most profitable services: Lending. The article’s opening paragraph says it all: “Banks have pulled back sharply on lending to U.S. consumers during the coronavirus crisis. One reason: They can’t tell who is creditworthy anymore.” A provision in the government’s stimulus program forbids lenders to report payments as late on a borrower’s credit report if they have allowed that borrower to defer their payments. The recent developments have forced banks uncertain of whether a person is creditworthy to not provide credit. As we have seen from recent Federal Reserve actions, the availability of credit is very important for the economy and financial asset prices. The Federal Reserve’s various credit programs ranging from lending directly to businesses to buying corporate bond ETFs directly from the market has produced a significant floor under asset prices. The Federal Reserve has already positioned itself as the third largest holder of the LQD (investment-grade corporate bonds) ETF.
Finally, the Federal Reserve wrote an important report titled, “Assessment of Bank Capital during the Recent Coronavirus Event”. To spare you from reading the 26-page report, our concentration was on page 6. It is on this page, where the Fed’s team of analysts made their “V-Shaped” Alternative Downside Scenario assumptions. They also covered “U-Shaped” and “W-shaped” recovery scenarios but the same financial asset stress model was used. In their V-shaped recovery model, the Fed projected, “… equity prices would still decline nearly 50 percent from their value on June 1, 2020, and BBB-rated corporate bond spreads in this scenario would peak at 550 basis points compared to the current level of about 300 basis points.” Is it worth taking on risk, even at half of the Federal Reserve’s downside projection (-25%), until we get some semblance of what the American Household looks like post-pandemic? TransUnion, one of the major credit-reporting agencies, said that more than 100 million accounts are currently in deferral status. This means there are a lot of households who are not current on their debt servicing payments, let alone on principal. As mentioned, a couple of times before, this is the time to be tactical and disciplined. We have studied quite a bit of information and some we presented here in this letter. Knowing that the S&P 500 has now made three failed attempts at the old highs and has yet to attempt to retest the lows is something to ponder. Thank you for your continued trust during these uncertain times. If you have any questions, you are encouraged to reach out to us!
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