2020 just keeps getting worse. As if a global pandemic and economic collapse weren’t enough, the death of George Floyd under the knee of a police officer on Memorial Day sparked a week of violent demonstrations throughout the United States, the breadth of which rivals the tumultuous summer of 1968. Protests like this are hardly without precedent, and the catalysts are lamentably familiar. What is different this time around is that most of the nation has been trapped at home for months, and over 40 million people have filed for unemployment insurance. This is an incendiary combination. People are already on edge – emotionally, financially and spiritually – and the scenes of looting and violence around the country threaten to push some people over that edge. With a fractious election in November, and the Republican and Democratic political conventions scheduled for August, it could be a long and hot summer.
Equity markets seem immune to these developments so far, focusing instead on welcome trends in the COVID-19 healthcare crisis, and the hope that state and local economies will succeed in cautiously reopening for business. The S&P 500 index has rallied 36% from the lows of late March, with 4.8% of this rally coming in May. Smaller capitalization stocks outpaced their larger brethren in May, posting a total return of 6.5%.
Equity markets outside the United States posted gains in May as well: The MSCI EAFE index of developed international markets rose 4.4% in May, while emerging markets eked out a small advance of 0.8%. Over longer time periods, however, large-cap domestic stocks have easily outperformed other equity classes, compounding at around 10% over the past three to five years, while small caps and international equities have tread water at best.
A quick look at sector performance helps to explain why the large-cap indices have performed so much better than other equity measures. As we discussed in last week’s Strategy Insight, a small handful of large technology companies account for over 20% of the S&P 500 index, and have driven the market higher for the past few months. The information technology sector of the S&P 500 is up 7.3% through the first five months of 2020 (versus -5.0% for the index), and up 22.8% annualized for the past three years.
To echo last week’s commentary, narrowly led markets tend to be fragile and volatile. If investor sentiment turns against the technology sector, or even against one or two names that have led the market higher, that could be reflected in a drop in the overall index.
Bond performance has been mixed. At the height of market anxiety in late March, investors shunned all assets other than short-term Treasuries, and the year-to-date performance of Treasuries reflects the appeal of this safe-haven status, as well as the Federal Reserve’s effort to push short-term interest rates down to zero. Bond investors embraced risk more enthusiastically in May, and municipals, corporates and junk bonds outperformed Treasuries. Longer performance periods exhibit a more normal relationship between risk and return.
It is a well-worn cliché to characterize these times as unprecedented. They’re not, except in the sense that they’re now happening to us. This nation – its people, economy and markets – have lived through periods of social unrest, pandemic and recession at various points in the past. To live through them all at the same time, however, is unnerving at best. While we are all wrestling with the implications of COVID-19 and social unrest for ourselves and our families, we remain committed to the safe stewardship of our clients’ capital. A disciplined approach to fundamental analysis and security valuation lies at the heart of our approach in any investment environment, and is particularly important in periods of such uncertainty and volatility.
Abraham Lincoln, as usual, said it best, concluding his first inaugural address with a plea to his fellow citizens:
We are not enemies, but friends. We must not become enemies. Though passion may have strained, it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land, will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.
Opinions, forecasts, and discussions about investment strategies represent the author’s views as of the date of this commentary and are subject to change without notice. References to specific securities, asset classes, and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations. Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners. © Brown Brothers Harriman & Co. 2020. All rights reserved. PB-03717-2020-06-01