High Tides

Fool’s Gold?

Despite the worsening virus situation, U.S. equity markets posted a robust +5.64% gain in July, on the heels of a healthy June gain of +1.99%. We believe that examining the relative performance of the S&P 500 versus gold reveals a fundamental phenomenon: the flood of money supply resulting from the Fed’s unprecedented quantitative easing policies in late spring continues to drive the performance of all financial assets.

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Election Day Jitters

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In the past months, COVID-19 has dominated both headlines and markets, overshadowing the coming U.S. presidential election in November. We expect this to change as fall arrives. This month, we examine market behavior around presidential elections as a guide to when and how this year’s election may have a discernible market impact.

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Mask Off

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The first half of 2020 saw a growing disconnect between financial market performance and economic indicators. Stock market returns as measured by the S&P 500 have been resilient on a year-to-date basis, despite record unemployment and other headwinds dominating the news.

This month we analyze two potential causes of the disconnect and show that while the S&P 500 may be a good index to invest in, it is a poor representation of the broader economy. Specifically, we show that the COVID-19 pandemic has led to (i) heightened disparity of S&P 500 constituent returns and (ii) because of this disparity, S&P 500 index returns have been driven predominantly by a small subset of firms, namely Facebook, Amazon, Netflix, Google, and Microsoft (the so-called FANGM). Because these stocks have relatively low labor input, their outsize performance is not representative of the broader labor market and the overall economy.

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Gold in the Time of Money Printing

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Money, money everywhere

A consequence of the extraordinary speed, breadth, and magnitude of the monetary and fiscal responses to COVID-19 is that money supply has increased at an unprecedented rate. The most commonly-used measure of money supply, the Federal Reserve’s M2 measure, has grown by over 12% ($1.9 trillion) since the beginning of this year and is expected to grow even more as the Federal Reserve implements the asset purchase commitments that it announced last month.

Investors concerned about the potential impact of this monetary impulse may be interested in assets whose prices are responsive to an increase in money supply. In this month’s market commentary, we examine how one of humanity’s oldest stores of value—gold—may behave in the current environment.

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Charting the Course for COVID-19

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March saw the COVID-19 pandemic explode across developed market economies, most notably in the United States and Europe. Governments imposed lockdowns that brought consumer travel, leisure, dining, and entertainment activities to what is essentially a total halt of indefinite length. Markets crashed precipitously: at its extremes, the S&P 500 fell over 30% from its February peak.

Gauging and pricing the impact of COVID-19

We view the market decline in March as pricing in the first-order effect of higher risk premiums associated with a series of upside surprises to the spread of COVID-19 and its impact on developed markets. In a recently released draft paper by the National Bureau of Economic Research (Alfaro et al., 2020), the authors show that changes in aggregate stock returns are forecasted by day-to-day changes in the predictions of simple models of the spread of infectious diseases. For this month’s commentary, we produce a simplified model of the same using data from the Johns Hopkins Center for Systems Science and Engineering. 

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Cutting to the Bone

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February saw the COVID-19 epidemic progress into a global pandemic that now touches every continent except Antarctica. The virus is expected to take a toll on growth not only in Asia, but also in developed markets in Europe and North America. Equities dropped steeply in response to this grim outlook, with the S&P 500 down nearly 16% at the extremes. In response, the Federal Reserve stepped in on March 3 with an unscheduled cut of 50 bps to the overnight federal funds rate (known as an “intermeeting cut” because it occurred between scheduled Fed meetings). Markets rallied briefly on this news before moving on quickly to continue their journey downwards. Lower interest rates may help corporate investment, but they will not get consumers back out to the movies or onto cruise ships.

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A Market Diagnosis for the Wuhan Coronavirus

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January saw the markets bedeviled by macro risks, with inflamed U.S.-Iran tensions followed by revelations regarding the spread and nature of the Wuhan coronavirus (also known as 2019-nCoV). The Federal Reserve committed to supporting “inflation returning to the Committee’s 2% target” (emphasis added), a pivot from previous statements that merely committed to supporting inflation “near” the 2% target. This was interpreted by the markets as a dovish tilt in the Fed’s policy stance.

A challenge that’s been seen before?

With the Wuhan coronavirus showing little sign of abating, we chose this month to analyze the impact of emerging market epidemics. We assume trends in Google searches for specific terms (e.g., “avian flu”, “ebola”, “zika”, and “coronavirus”) are indicative of media coverage and market anxiety. To that end, we use Google Trends, which indexes the number of Google searches for a particular term over time.

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What the Current U.S.-Iran Tensions Could Mean for Asset Allocation: Lessons from Past Conflicts

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The opening days of 2020 saw the news dominated by coverage of the U.S. attack on Iranian Major General Qasem Suleimani, with markets focused on the attack’s implications and Iran’s response. As of writing, U.S.-Iran hostilities appear to have stabilized for the time being, with Iran facing domestic protests following its admission that it mistakenly shot down a Ukrainian airliner.

In light of these circumstances, we look to prior instances of U.S. military involvement in the Middle East and subsequent performance across U.S. equities, crude oil, gold, 10-year yields, and the U.S. dollar. Specifically, we analyze the days following the 1986 U.S. bombing of Libya, the 1990 inception of the First Iraq War (Gulf War), and the 2003 American invasion of Iraq. Our findings are summarized in the table below.

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