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The Economy and the Markets | Second Quarter 2020

Key takeaways

  • Markets rebounded as investors came back in force.
  • The pandemic economy is a uniquely challenging situation with little historical context.
  • Unprecedented liquidity and a strong dose of hope are fueling investor demand despite a myriad of structural imbalances.

Volatility remains elevated on continued uncertainty

As the pandemic raced across the globe, economies came to a halt one by one, triggering a severe global recession. In the midst of the worst downturn in decades, why are markets so resilient? Appearing encouraged by the promise of ongoing policy support and facing limited yields in safe assets, investors came back in force. The recovery was powerful after markets plunged in March. Stocks returned 14%-30% in the quarter, and commodities produced a 5% return. High-yield and investment-grade corporate index spreads fell by 254 basis points (bps) and 152bps, respectively. Despite the bounce, returns on vulnerable sectors remain in negative territory for the year with real estate investment trusts (REITs), small cap stocks, commodities and foreign stocks all down double digits. Yields remain anchored near record lows, and the 10-year treasury rate ended the quarter at a paltry 0.66%. Most points on the yield curve ended the quarter within 10bps of where they started. Aside from the government bond market, volatility remains elevated on continued uncertainty.

Rates are at rock bottom.  The 10-year yield is near a record low.


10 yr treasury yield

Source: Bloomberg. As of 7/01/2020. Data spans from 6/30/1962 - 7/01/2020.

The Federal Reserve’s (the Fed) policies reflect its determination to make sure that credit reaches Main Street and that market liquidity remains robust. The Fed has expanded far beyond its traditional tools to control monetary conditions and facilitate lending through banks. An unprecedented level of quantitative easing increased the bank’s holdings of treasury and mortgage-backed securities by trillions of dollars in a matter of weeks. With the federal funds rate target already at zero, the central bank turned to expanded security purchases across a broad range of asset classes including corporate bonds, municipal securities, and fixed income Exchange-Trade Funds (ETFs). In addition, the Fed is funding direct corporate lending to small and medium businesses. Investors appear to be following the Fed’s lead and pouring capital into sectors that the central bank is buying. Corporate bond issuance of more than $1 trillion so far this year has been met with strong demand. 

Despite historically low rates and record government bond issuance, investors don’t think yields are going higher any time soon. Fed policymakers seem unlikely to support a negative rate policy to stimulate the economy, but market participants think that yield curve control (targeting longer term yields) and average inflation targeting (allowing inflation to run “hot” before tightening monetary policy) are probable tools. Both policies are likely to suppress fixed income returns over time. 

2020 is shaping up to be the biggest decline in Gross Domestic Product (GDP) since the 1940’s.


Real gdp growth q2 2020

Source: Bloomberg. As of 07/01/2020. Data spans from 01/01/1930 – 12/31/2020 (forecast).

The U.S. officially entered a recession in the first quarter, and we believe this downturn is likely to be far deeper, but shorter, than the Great Financial Crisis. The picture for global growth is equally bad as COVID-19 spares no nation. The International Monetary Fund predicts that global economic output will fall by almost 5% in 2020. The full force of the U.S. economic shutdown is expected in the second quarter. We expect the economy to shrink at an annualized rate of between 25% and 30%, quarter over quarter.  Economists expect a rebound in the second half that will limit the full year decline in the U.S. to between 5% and 7% compared to 2019. The initial bump from reopening has been better than expected after unemployment spiked to almost 15% in April.  Government aid, in the form of expanded unemployment benefits, cash payments, and the Payroll Protection Program, has supported spending. Employers brought back workers in May, reducing the unemployment rate to 11.1% in June. Companies are coming to grips with a starkly different environment than they expected at the beginning of the year. CEOs are reducing capital spending and hiring plans, a factor that will be a persistent drag. Economic research indicates that growth will be guided as much by the public’s view of risk as policy decisions. As states reopen, cases are spiking once again, raising concerns that the nascent recovery might be at risk.

This makes forecasting especially difficult as investors try to anticipate the complex interaction between perceived risk, policy actions, and the unfolding recession. It is uncertain how well current economic data is capturing underlying economic fundamentals given significant policy distortions and questions about consumer behavior. This is an epic downturn that’s been met by an epic policy response. It’s not clear where the economy and markets would settle out without the $2 trillion in spending under the Coronavirus Aid, Relief, and Economic Security (CAREs) Act and the Fed’s bond buying. Investors, with little historical context to draw on, are falling back on a hopeful view. We’re not as certain and are concerned that the recovery may be stymied as the nation struggles to control outbreaks and Congress tentatively dials down fiscal support. 

Markets are trading on unprecedented liquidity and a strong dose of hope, not on fundamentals. We are facing a myriad of imbalances, and policymakers will have to navigate them perfectly to justify current pricing. These challenges include high levels of debt in the corporate sector, unexpected structural changes to the economy stemming from the virus, and massive income and wealth inequality. The last challenge has been hiding in plain sight for over 20 years. Globalization, a shift in our economy towards services, and tax and monetary policies that favored owners of capital have accelerated and entrenched disparities. The pandemic simply exposed an imbalance that was already there. Social unrest is one sign of the times, and the coming election will continue to raise demands to address these issues through tax, spending and policy reforms. We expect the road to recovery to be bumpy and think the market is too cavalier about the prospects for rising bankruptcies, sticky unemployment, and political uncertainty. Beyond the moral imperative to shore up our civic foundation, our economic vitality depends on getting this right.

Don't fight the Fed!

"When it comes to this lending, we’re not going to run out of ammunition."

Fed Chairman, Jerome Powell in a 3/26 interview with Savannah Guthrie, NBC news

Source is Bloomberg, Federal Reserve, and Securian Asset Management, Inc. for all information, unless noted otherwise.

Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. This commentary should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. Investors should keep in mind that markets are volatile and unpredictable. Past performance is no guarantee of future results. Opinions expressed herein are those of Securian Asset Management, Inc., only. The Economy and the Markets has been prepared for informational purposes only and is the opinion of Securian Asset Management, Inc., a registered investment advisor.

Securian Asset Management, Inc., is a subsidiary of Securian Financial Group, Inc.

For Institutional Investment Use Only. Not for redistribution or public use.

DOFU 7-2020