an economic & market commentary from trust point

Second Quarter 2020 | Issue No. 30An Economic & Market Commentary from Trust Point

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Second Quarter 2020Market Point

An Economic and Market

Update from Trust Point

The second quarter was characterized by a rebound in equity and

credit markets. Open-ended commitments from governments and

central banks have been critical in cushioning the economic downside

associated with the rapid spread of COVID-19 around the world. As

always, we remind our clients to remain focused on the long term and

think about the current environment as an opportunity, not a threat to

their financial well-being.

After experiencing a severe

shutdown of global economic

activity in late Q1, pent-up demand

led to improvements in the second

quarter. However, as new coro-

navirus hot spots have recently

started to flare up (Chart 1), talks

of a “second wave” are picking up.

While we recognize the recovery

will be bumpy, we are optimistic

that potential future “waves” will

not have the same financial and

economic impact as the first one.

Although much is still unknown

about this novel virus, we have and

will continue to adjust. For one,

testing capacity has ramped up

dramatically and contact-tracing

is improving in many countries,

allowing authorities to identify

and contain resurgences more

quickly. Local authorities provide

daily updates, helping the public

be aware of new hot spots devel-

oping, prompting public awareness

and more preventive actions. In

addition, out of necessity, the

“Swedish model” favoring voluntary

social distancing appears to be the

new way of dealing with COVID-19

for most countries. Along with gov-

ernments, the populace appears

willing to tolerate a wider rate of

infections and deaths in exchange

for greater mobility. In summary,

flare-ups are likely and could

temporarily unnerve investors, but

as long as the number of hospital-

izations remains below health care

capacity, we believe a return to

widespread and lasting lockdowns

is unlikely.

COVID-19: Two Steps Forward, One Step Back

Dollar Index Level June 97.4 99.0 96.1

As of Actual 3 Mos. Ago 1 Year Ago

ISM Manufacturing (>50 = Expansion) June 52.6 49.1 51.6

ISM Non-Manufacturing (>50 = Expansion) June 57.1 52.5 55.4

Non-Farm Payrolls June 4800k -1371k 182k

Unemployment Rate June 11.1% 4.4% 3.7%

CPI Ex-Food & Energy (yoy) May 1.2% 2.4% 2.0%

JP Morgan Global Manufacturing Index (>50 = Expansion) June 47.8 47.3 49.4

JP Morgan Global Services Index (>50 = Expansion) June 48.0 36.8 51.9

US Economic Activity

KEY ECONOMIC DATA

Global Economic Activity

Source: Bloomberg

Source: Johns Hopkins University Center for Systems Science & Engineering (CSSE), MRB Partners

150 150

100 100

50 50

0 0

01-2020 02-2020 03-2020 04-2020 05-2020 06-2020

** 7-day moving average

Total

Active

Chart 1: Daily Change in Cases**(000s)

Market Point Second Quarter 2020

Interestingly, the November elections

have so far taken a backseat to the

pandemic in terms of impact on fi-

nancial markets. It is worth noting,

however, that the pandemic and re-

cent widespread protests calling for

social justice have quickly boosted

odds that Democrats could come out

ahead. This marks a significant shift

from where we were at the begin-

ning of the year. To start with, politi-

cal experts generally agree the U.S.

House of Representatives is likely to

remain in control of Democrats. For

the presidency, betting markets are

now giving Democrat Joe Biden a

slight advantage over Republican

President Donald Trump (Chart 2),

and they suggest a slight advantage

to the Democrats on taking control

of the Senate as well. A Democrat-

ic Party sweep would put the 2018

Trump tax cuts at risk. The effec-

tive tax rate for corporations, which

dropped from about 24% to less than

18%, could increase as Biden has

proposed to remove about half of

the reduction (Chart 3). The timing of

such a change remains unclear giv-

en the current economic situation. In

addition, reregulation and increased

entitlement spending also would be-

come more likely over time.

What Else We Are Watching

Two opposite forces are currently

influencing the global economy. On

the one side, COVID-19 has led to a

sharp contraction in consumer and

business activity. As a result, corpo-

rate income and revenues have dried

up and layoffs have been pronounced.

On the other end, fiscal and monetary

support have been provided to keep

everyone solvent. The open-ended

commitment from the authorities

to essentially “do whatever it takes”

has been critical and well received

by financial markets. More support

should be expected because, short

of effective virus treatments and/or

vaccines, consumers and business-

es will remain cautious. While we will

not be back to normal for some time,

investors need to reassess what the

“new normal” will look like and adjust

portfolios accordingly. History tells us

every crisis leads to transformational

changes and this one should be no

different. For example, suburban liv-

ing has gained in appeal as people

are looking to flee crowded cities and

the work-from-home concept gains

more acceptance. Businesses have

realized one-meeting trips overseas

to see a client face to face can be

handled effectively by the click of a

button. Those are just two examples

of potential transformational changes

that could have long-lasting effects.

Crises Bring OpportunitiesChart 2: Biden in the Lead to Win the U.S. Presidential Election

Source: Predictit, MRB Partners

55 55

50 50

45 45

40 40

03-2020 04-2020 05-2020 06-2020

U.S. 2020 Election Probabilities (%):Biden Wins the Presidential Election

Chart 3: Corporate Tax Rates Could Increase Following a “Democratic Sweep”

Source: S&P Capital IQ Compustat, Ned Davis Research

Effective rate fell from 24.3% to 17.7% after

tax cuts

53 5352 5251 5150 5049 4948 4847 4746 4645 4544 4443 4342 4241 4140 4039 3938 3837 3736 3635 3534 3433 3332 3231 3130 3029 2928 2827 2726 2625 2524 2423 2322 2221 2120 2019 1918 1817

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 202017

S&P 500 Effective Tax rate (2019-12-31 - 17.7%)

An Equity Market


Market Point

Global equities soared in the second quarter behind massive monetary

and fiscal stimulus, a flattening COVID-19 infection curve, positive news

about vaccine developments, and optimism over economic reopenings.

In the quarter, the S&P 500 index increased 20.5% while the MSCI ACWI

ex-U.S. index ascended 15.3%. The market volatility appears to assume

a V-shaped economic and earnings recovery, thereby increasing risks

to near-term equity prices should the economic improvement stumble

along the way.

Second Quarter 2020

S&P 500 3,100 2,585 2,942 2,423 2,063Dow Jones Industrial Average 25,813 21,917 26,600 21,350 17,620NASDAQ 10,059 7,700 8,006 6,140 4,987

US Large Cap Growth 27.8% 9.8% 23.3% 19.0% 15.9%US Large Cap Value 14.3% -16.3% -8.8% 1.8% 4.6%US Mid Cap Growth 30.3% 4.2% 11.9% 14.8% 11.6%US Mid Cap Value 19.9% -18.1% -11.8% -0.5% 3.3%US Small Cap Growth 30.6% -3.1% 3.5% 7.9% 6.9%US Small Cap Value 18.9% -23.5% -17.5% -4.3% 1.3%

International Large Cap Developed (US Dollar) 14.9% -11.3% -5.1% 0.8% 2.1%International Small/Mid Cap Developed (US Dollar) 19.9% -13.1% -3.5% 0.5% 3.8%

Emerging Market (US Dollar) 18.1% -9.8% -3.4% 1.9% 2.9%

Quarter-End 3 Mos. Ago 1 Year Ago 3 Years Ago 5 Years Ago

3 Month YTD 1 Year (Ann) (Ann)

3 Year 5 Year

US Economic Activity

EQUITY BENCHMARK TABLE

Equity Returns (%)

Source: Bloomberg, Morningstar

Equity Bounce Has Been One for the Ages, But It Might Be Deceiving

Global equities rebounded 19.2% in

the second quarter. Since 1970, this

is the largest 3-month return of equi-

ties after a pandemic, higher than the

bounce after the Swine Flu epidemic

in 2009, and one of the largest ever

after a recession. Massive monetary

and fiscal commitments drove the

market rebound. Using the S&P 500

as a U.S. market proxy, over 20% of

the index’s value is now comprised

of just six stocks: Facebook, Ama-

zon, Netflix, Microsoft, Apple, and

Alphabet’s Google. These stocks

have been market darlings for years

but more recently their ability to act

as “safe-havens” during the pandem-

ic has only driven their stock prices

higher compared to the rest of the in-

dex (Chart 4). The combined year-to-

date market-weighted performance

of these stocks is up 23.5% com-

pared to down 11.3% for the other

494 companies in the index. It should

not necessarily come as a surprise

these stocks have outperformed giv-

en their stable profit margins/cash

flow generation and strong balance

sheets, perhaps justifying their val-

uations now and pre-pandemic.

However, a full market recovery will

require contributions from more than

these chosen six.Source: Ned Davis Research (FAAMG: Facebook, Amazon, Netflix, Microsoft, Apple, Alphabet’s Google); S&P Dow Jones Indices

Chart 4: FANMAG Leadership

355

S&P 500 Index vs FANMAG (Cap-Weighted)

FANMAG (2020-06-29 = 380.61)S&P 500 Index (2020-06-29 = 148.29)S&P 494 Index (S&P 500 ex FANMAG)(2020-06-29 = 125.53)

355

316 316

282 282

251 251

224 224

200 200

178 178

158 158

141 141

126 126

112

All Indexes allocated to 100

112

100 100

89 89

Jan

2015 2016 2017 2018 2019 2020

Jan Jan Jan Jan JanApr Apr Apr Apr Apr AprJul Jul Jul Jul JulOct Oct Oct Oct Oct

Ticker Name

FB Facebook

AMZN Amazon.com

NFLX Netflix

MSFT Microsoft

AAPL Apple

GOOGL Alphabet

Index (Cap-Weighted)Gain/Annum%

2014-12-31 to 2020-06-29YTD%

2019-12-31 to 2020-06-29

FANMAG 27.52 23.49

S&P 500 Index 7.43 -5.50

S&P 494 Index (S&P 500 ex FANMAG)

4.22 -11.30


Historically, we tend to see global

equities track earnings growth ex-

pectations relatively closely – this is

often referred to as the market fol-

lowing “fundamentals.” However, in

recent months, we have seen equi-

ty prices decouple from 12-months

forward earnings growth expecta-

tions (Chart 5). Equity markets have

risen rapidly while earnings growth

expectations continued to decline.

The markets are forward-looking, but

they appear to be looking beyond

2021 earnings growth, which itself is

currently expected to be higher than

a low-bogey 2020 earnings growth

forecast, but only in line with 2019

earnings growth. Earnings growth

forecasts more than 12-18 months

out are often difficult to predict (even

in normal times), so growth expecta-

tions beyond 2021 still appear quite

fragile. As a result, it is difficult for us

to justify becoming more construc-

tive on adding to equity exposure in

our asset allocation models. Shorter

term, equity prices could be impact-

ed by higher corporate pandemic-re-

lated operating costs, less corporate

stock buybacks (and potentially an

increase in share-diluting stock issu-

ances to shore up balance sheets),

greater debt-servicing costs and

potential negative tax implications

based on the 2020 presidential elec-

tion outcome.

Earnings Growth Expectations Not Yet Improving

Related to our earnings growth dis-

cussion above, absolute U.S. equity

valuations (Chart 6) have become

extremely stretched during the pan-

demic, trading at 15-year highs. Fur-

ther, the U.S. tends to have struc-

turally higher valuations relative to

the rest of the world due to sector

composition, but the relative over-

valuation has become even more

pronounced throughout the pan-

demic. Despite the lofty valuations,

however, equities do remain attrac-

tive relative to bonds. The current low

interest-rate environment, which is

expected to last for some time given

recent comments by the Federal Re-

serve and the long-term implications

of higher debt levels at the govern-

ment and corporate levels, means

interest income from bonds is ex-

pected to remain low. The concept

of “TINA” (There Is No Alternative)

should continue to make equities a

more favorable return vehicle relative

to bonds over the next many years

even with high absolute valuations

for equities.

Absolute (U.S.) Equity Valuations Rich; Relative Valua-tions Still Attractive

Chart 5: Earnings Estimates Have Taken It On The Chin

Source: MRB Partners

*U.S. dollars; rebased; smoothed; source: MSCI**Truncated below -40; U.S. dollars; smoothed; source: MSCI***U.S. dollars; smoothed; source: Netherlands Bureau for Economic Policy Analysis

Stock Prices*12-Month Forward Earnings*

Global:

Contracting

Diverging

12-Month Forward Earnings** (%YoY)Export Value*** (%YoY)

160 160

120 120

80 80

20 20

0 0

-20 -20

-40 -40

2008 2010 2012 2014 2016 2018 2020

Chart 6: Rich Valuations are a Short-Term Risk For the U.S.

Source: MRB Partners

*Source: MSCI**Percent premium (+) or discount (-)

2020

1515

1010

4040

2020

00

20082006 2010 2012 2014 2016 2018 2020

Global ex-U.S.U.S.

12-Month Forward P/E Ratio*:

U.S. / Global Ex-U.S** (%)

Very elevated

Very stretched

Federal Reserve Chairman Jerome

Powell made it clear at June’s FOMC

(Federal Open Market Committee)

press conference that the Fed will

continue to support the U.S. econ-

omy. The Chairman was asked

specifically about the potential risk

that ongoing massive stimulus could

create bubbles in financial asset pric-

es by artificially propping up markets.

Powell’s response focused solely on

the millions of unemployed workers

and he stressed the Fed should not

hold back on monetary stimulus. The

range and scope of the programs

support numerous sectors of fixed-in-

come markets, businesses of all siz-

es, households, and state and local

governments. Among others, the

Fed has promised to buy up to $750

billion in corporate bonds through

individual securities and ETFs. State

and local governments stand to ben-

efit from a $500 billion facility as well.

The new facilities are on top of mas-

sive purchases of Treasury, agency,

and mortgage-backed securities

intended to keep borrowing costs low

while injecting much-needed liquidity

into markets. So far, the Fed has just

begun to implement these programs,

but the mere announcement of these

facilities and implied support has

had a strong positive influence on

markets (Chart 7).

Federal Reserve Is Just Getting Started

A Fixed Income Market


Market Point

The Federal Reserve is mandated from Congress to promote full

employment and stable prices, along with its duties to promote stability

in the financial system. The Fed is using its full range of tools, and some

new ones, to attempt to achieve these mandates. The second quarter

can be characterized by a rebound in the corporate bond market, falling

volatility, and increased liquidity as the Fed has quickly stepped in to

provide relief and stability.

Second Quarter 2020

3 Month T-Bill 0.1% 0.1% 2.1% 1.0% 0.0%2 Yr US Treasury 0.2% 0.2% 1.8% 1.4% 0.6%10 Yr US Treasury 0.7% 0.7% 2.0% 2.3% 2.4%

US Intermediate Treasuries 0.9% 9.6% 11.1% 6.1% 4.5%US Treasury Inflation Protected Sec. 4.2% 6.0% 8.3% 5.0% 3.7%US Mortgages 0.7% 3.5% 5.7% 4.0% 3.2%US Short-Intermediate T/E Munis 3.0% 2.1% 3.7% 3.1% 2.7% US Investment Grade Corporates 9.0% 5.0% 9.5% 6.3% 5.8%US Senior Bank Loans 9.7% -4.6% -2.0% 2.1% 2.9% US High Yield 9.6% -4.8% -1.1% 2.9% 4.6%US Convertibles 24.2% 7.2% 15.3% 11.7% 9.2%

Int’l Bonds Ex-US (Hedged) 1.1% 2.6% 4.3% 5.3% 4.9%Int’l Bonds (Unhedged) 3.3% 3.0% 4.2% 3.8% 3.6%

Emerging Market Debt (US Dollar) 11.2% -1.9% 1.5% 3.3% 5.1%

Quarter-End 3 Mos. Ago 1 Year Ago 3 Years Ago 5 Years Ago

3 Month YTD 1 Year (Ann) (Ann)

3 Year 5 Year

US Yields (%)

FIXED INCOME BENCHMARK TABLE

Global Economic Activity

Source: Bloomberg, Morningstar

Source: The Economist

Chart 7: U.S. Fed is Just Getting Started with CreditLending Facilities

1,100

$, billionsTreasury backstop

OE forecast

Fed program limit

Actual thus far

1,000

900

800

700

600

500

400

300

200

100

0Term Asset -

Backed Corporate

CreditFacility

PPPLiquidity

MunicipalLiquidity

Main StreetLendingProgram

Money MarketFund

CommercialPaper

Funding


At the last FOMC meeting, the Fed

indicated it is likely to keep interest

rates at the zero-bound level through

2022. The market has bought into

this as the Fed Funds rate, which

represents market expectations for

short-term rates, has priced in no

interest-rate hikes through 2022 as

well (Chart 8). What this means for

markets is that the Fed will continue

to provide a backstop and keep

borrowing costs low to support

economic growth. This is a powerful

message which helps to explain why

longer-term bond yields have stayed

relatively low at the same time as eq-

uity markets have recovered much of

the March losses. The Fed has indi-

cated they are not considering nega-

tive interest-rate policy in the U.S. as

they have studied the lack of desired

results from this type of policy in Eu-

rope and Japan. We believe the Fed

may go a different direction and soon

announce measures for controlling

yields in government bonds, known

as yield-curve control. By capping

yields at certain levels, the Fed can

cap longer-term borrowing costs for

the government while also keeping

borrowing rates low for businesses

and consumers.

Lower For Longer – The New Normal

Toward the end of the quarter, the

10-year Treasury yield began to

slowly rise after falling to all-time lows

of around 60 bps in April. However,

with the Fed not likely to change

policy soon, it will be difficult for

Treasury yields to get back to 2019

levels anytime soon. On the other

end, propelled by unprecedented

policy support and optimism over

economies opening back up, credit

markets rallied strongly. The risk

premium in high-yield corporate

bonds, also known as Spread to

Treasuries, fell from 10-year highs

of 11% to just below 6% (Chart 9).

The extra yield investors require to

hold riskier corporate bonds remains

elevated relative to historical levels

and we believe there is still opportu-

nity in these markets. Higher quality

investment-grade corporate bonds

have also benefited from direct Fed

purchases and support, with prices

rising from recessionary levels

during the second quarter. We have

taken advantage of some of these

opportunities in the corporate bond

market that arose during the market

correction. However, we remain

tempered in our positions as we

are closely watching a resurgence

of new cases of the virus that could

lead to increased risk-off sentiment in

the short term.

Markets Stabilize in Q2

Chart 8: Fed Has Lowered The Fed Funds Rate Back To Zero Bound

Source: BCA Analytics

US Fed Funds Rate

US Fed Funds Rate: Expectations derived from OIS curve

US Fed Funds Rate: April survey of market participants median estimate

Jan ‘20 Jul ‘20 Jul ‘21 Jan ‘22 Jul ‘22

22

1.51.5

11

0.50.5

00

-0.5-0.5

%%

Jan ‘21

Chart 9: Corporate Bond Spreads Recover During Q2

Source: Bloomberg

6.0020

15

10

5

5.00

4.00

3.00

2.00

1.00

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

1.51

5.94

High Yield Spread (R1) 5.94

Investment Grade Spread (L1) 1.51


Key Investment Themes

Macroeconomics

Asset Allocation

Fixed Income

Equities

• Structurally, Debt, Demographics, and Deglobalization may influence global growth and inflation for years

• Cyclically, growth had been stabilizing in Q4,19 but Covid-19 will slow it down in 1H, 2020

• Economic recovery expected in 2H, 2020 but uncertainty about the path and strength of recovery remains

• Biggest wild cards for 2020: Coronavirus vs monetary and fiscal responses

• Tactically, the risk/reward outlook slightly favors fixed income over equities

• Low bond yields & pricier equity valuations call for modest returns from financial assets over the next 3-5 yrs

• Global macro uncertainty has important implications for various sub-asset classes /sectors

• Important to maintain a diversified approach and not let emotions dictate investment decisions

• Government bond yields have collapsed. They do not offer attractive value for the long-term investor

• Overweight USD denominated debt over local-currency international bonds

• Very low yields on high quality bonds provide little value. Stay short duration

• Credit sensitive bonds offer better value and should outperform high-quality bonds in the year ahead

• Equities have been driven by news related to Covid-19, policy responses and their macroeconomic impact

• Volatility will remain elevated until investors get more clarity on the outlook going forward

• Earnings estimates have been revised down. Q2 earnings will be weak but 2H earnings should improve materially

• Hedged U.S. equity strategies offer good value in an increasingly volatile market environment


Tactical Asset Allocation

Equity

- Underweight + Overweight

Fixed IncomeAsset

Allocation

ValueLarge Cap

Consumer Staples

GrowthMid & Small Cap

Consumer DiscretionaryEquity

Interest-rate riskGovernment Debt

Foreign Bonds

Short-Term BondsInflation Protection

Corporate Credit

FixedIncome

We increased equity exposure during the quarter but remain cautious with an underweight equity position in portfolios. Within equities,

we have increased small cap exposure given the extreme relative outperformance of large caps while maintaining a growth bias. Mon-

etary and fiscal policy have increased our appetite for corporate credit within fixed income portfolio as we added to credit during the

quarter given more attractive valuations. This has benefited portfolios during the recovery. We also increased duration as the outlook

for interest-rates has come down given Federal Reserve policy. However, we remain cautious with interest-rate risk as investors are not

being paid to take substantial interest-rate risk in long-term government bonds. We continue to position portfolios to ensure that we can

provide the best risk-adjusted returns without taking unnecessary risks.

Profile Summary

Tactical Asset Allocation

Individual client portfolio positioning, performance and transactions therein can vary greatly based on factors including investment strategy, objective, limitations, risk tolerance, time horizon, asset allocation and tax implications.

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Market Point is a quarterly market commentary designed to provide you with an overview of economic conditions, as well as equity and

fixed income market summaries for the quarter.

This commentary is offered by the Investment Management team. The individuals contributing to Market Point are pictured from left to

right: Randy Van Rooyen, CFA®, Yan Arsenault, CFA®, CAIA, Ryan Bergan, Steve Brudos, Brandon Hellenbrand, CFA®, Brett Sebion,

and Christine Doll. Please feel free to contact any team member with questions.

The opinions herein are those of Trust Point Inc, are made as of the date of this material, and are subject to change without notice. Trust Point uses its best efforts to compile its data from reliable sourc-

es, however, it does not warrant the accuracy, completeness or timeliness of any of the information provided. This publication is prepared for general information only. This material does not constitute

investment advice and is not intended as an endorsement of any specific investment. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies

discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. All investing involves the risk of loss, including principal, a reduction in

earnings, and the loss of future earnings. Past performance is no guarantee of future results. Individual client portfolio positioning, performance and transactions therein can vary greatly based on factors

including investment strategy, objective, limitations, risk tolerance, time horizon, asset composition, asset allocation and tax implications.

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