Quarterly Commentary

2Q 2020

Stocks and bonds staged a remarkable recovery in the second quarter, leaving many observers questioning whether markets have lost touch with reality. New Covid cases are surging in some parts of the US that were relatively unaffected during the first phase of the pandemic, pausing and in some cases reversing plans to reopen certain sectors of local economies. The continuing uncertainty creates unusual tensions as we go about our daily lives and plan for our futures. To say the least, the disconnect between the virus headlines and the stock market rebound is complicated.

The Race for a Vaccine
Lost in the alarm about new cases is continuing progress on treatment and vaccines. The use of antivirals, steroids and other already available drugs has been shown to improve outcomes for hospitalized Covid patients. As medical providers have shared best practices and utilized these new therapies, mortality rates have dropped considerably. Meanwhile, in a remarkable two months’ time, researchers identified the virus and began testing potential vaccines on humans. A July 8 research report from Morgan Stanley laid out expected timelines for three Phase III vaccine trials. Pfizer, Moderna and AstraZeneca are each expected to enroll 30,000 individuals this summer. Each could be posting data in September/October, and if efficacy justifies, requests for accelerated approval could be filed in November. Moderna has indicated its intention to jumpstart manufacturing its vaccine ahead of any trial results, indicating that 100 million doses could be available in a few months. On June 2nd, Dr. Anthony Fauci said, “I’m cautiously optimistic that with the multiple candidates we have with different platforms, that we are going to have a vaccine that will make it deployable by year-end.” 

Vaccine trials are “event-driven,” meaning that analysis begins once a geographically-defined control group (receiving placebo) contracts a predetermined number of infections. Ironically, the surge in new cases in the southern and western US means that some of this critical testing can take place on American soil, presumably expediting the process.

Consumer Optimism
We believe that continued progress on treatments and vaccines would go a long way in inspiring patience and optimism when it will be needed most -- as cooler weather forces many Americans to resume their lives indoors. Consumer confidence here in the US has already proven to be surprisingly resilient, even in the face of higher unemployment than in the 2008-2009 period. This is likely a function of the aggressive monetary and fiscal response to the crisis. For the time being, income gaps have been filled and many lower wage earners are better off than before. Expectations are running high that there will be another round of stimulus. 

The Market Disconnect
On the surface, it may appear that the stock market could not be more divorced from current economic circumstances in the US. Although the S&P tumbled badly in March, it had recouped almost all of its losses by early June. Taken as a whole, the market looks expensive. Scratching beneath the surface, it becomes clear that investors are in fact not pricing in an all-clear on the economy - everything is not A-Okay. It is just a handful of tech names that account for 25% of the S&P that continue to underpin the broader index. Indeed, the valuation disparity between growth and value stocks is at record highs. The last time there was such a large gap was the tech bubble in 2000. This is a reflection that investors are scared. They have flocked to what they view as “pandemic proof” tech companies with outsized earnings growth, balance sheet strength, and the potential to emerge from the crisis even more powerful. If they were more confident about an enduring recovery, they would be piling into cyclical stocks, deep value and reopening plays, not leaving them for dead.

On Investment Horizons
Our investment committee recognizes the need to strike a balance between positioning portfolios for the pandemic and for its eventual aftermath. Jittery markets and skewed valuations tell us that the market is currently more focused on the next few months than the next few years. While we agree that near-term risks should not be ignored, there is potentially significant opportunity for those with patience, willing to take a long-term view.

In the coming weeks, we will learn a great deal more about the impact of evolving social distancing policy on the spread of the virus and the economic recovery, additional fiscal stimulus, and progress towards a Covid vaccine. With second quarter earnings reporting just getting underway, we will also gain deeper insights into how companies are faring amidst the current challenges and how managements are rethinking their strategies for the years to come.

We hope you are able to get outside and embrace the hot summer weather.