Portfolio Research Director, Kevin E. Donovan, CFA, shares his thoughts on the strong market performance in the second quarter and what to look for in the days ahead.

Kevin E. Donovan, CFA
Kevin E. Donovan, CFAPortfolio Research Director

Hello, I’m Kevin Donovan, portfolio research director for CJM Wealth Advisers. And we’re going to talk about the second quarter today. Obviously a lot happened around the world in the US, and the economy and the markets in the second quarter. I’m going to focus today, talking about the markets, a little bit about the economy and where we expect to go from here. So second quarter, one of the best quarters in stock market history. It’s strange that it happened during a period of economic collapse, but as we’ll talk about, the markets are always looking forward, economic data is usually backward looking. So obviously the markets seeing economic recovery in the cards. And you can see from the chart here, the second quarter results were great. It was the best quarter for the S&P 500 since 1998, it was up 20%. Dow was almost as good up almost 18%. International stocks did well, and even bonds were up.

So it was a great quarter from a financial markets perspective and for your investments. But if you look at year to date numbers, we’ll see that almost everything is still negative, bonds of showing a healthy 6% return, which is good, which is what we want bonds to do when stocks go down. But as you can see, the S&P 500 is still down 4% as best performing of the next is on that chart right there. And whats doesn’t show though, is that there is a great difference in returns between growth stocks and value stocks. So in particularly the technology industry is doing extremely well this year. And you own some large company growth funds in your portfolios. Those funds are typically positive year to date. On the value side, that is not the case. We’re talking about funds that hold companies in the energy industry.

So oil companies have been hit hard by dropping oil prices. Banks haven’t done very well because the federal reserve lowered interest rates dramatically, and banks need higher interest rates to get more margin. So those areas have not done quite as well as the technology growth stocks, and also obviously have caught of course, travel stocks and some consumer stocks have not done so well. The next chart is just to show though how well we did since the bottom of the market. Now the stock market rebound started about a week and a half before the second quarter started. And a lot of those gains happen in those first few days like it usually does when markets come off their bottom. So you see here the down the S&P both up around 38%, international and emerging market indexes up about 31%, and even bonds up 5% since the bottom of the market.

What this is kind of masking though, and what you don’t see if you just looked at the market numbers is that the economy is not doing well. Unemployment, millions of people are unemployed that were employed just five months ago. And with the shutdown of the economy, it’s really slowed down and decreased our gross domestic product. As I said earlier, a lot of the economic signs the data that we get are backward looking. We are starting to see an improvement in unemployment, so unemployment kind of peaked around 13%, 14% since then it’s come down a little bit. But also what that doesn’t show is that the economies that have reopened are partially shutting down again because of assertion infections in certain areas of the country. So our latest employment numbers do not take into account this recent surge in infections of COVID-19. So we’ll see, within the next few weeks, what the unemployment numbers say as some restrictions are placed on some areas of the country. Other areas of the country are accelerating the reopening plans, but places like Texas, Arizona, Florida, or we’re going to see more restrictions being put on.

So the question for markets really is, have they gone too far too fast? Is this dramatic increase in stock prices 38% off of their lows? Is that warranted based upon what we expect the economy, the rate of economic improvement to be? Now one way to look at this, there are a lot of different valuation measures, but right now we’re going to look at forward P/E ratios. And as you can see from the chart here, we are near an all time high in the P/E ratio. So what this is the price of the S&P 500 divided by the expected 12 month earnings going forward for those companies in the S&P. Now what this doesn’t show, and one thing to keep in mind, is that a lot of companies withdrew their guidance. So some companies would say what they expect their earnings to be. An analyst would base their estimates on that guidance.

When a lot of companies withdraw their guidance, analysts kind of left in the dark and have to make guesses about what they expect earnings to be, and they tend to become more conservative. So earnings expectations have come down dramatically for the second quarter. So when the denominator earnings drops, that makes the price earnings ratio goes significantly higher. We have earnings season coming up within the next three weeks to four weeks, and we’ll be able to see based on the earnings that we see if analysts have underestimated the earnings. If they have, if earnings are better than expected, that will provide some support for valuations going forward. If earnings are worse than expected, the opposite will probably happen.

So this is a very crucial earning season coming up within the next couple of weeks. That’ll be the next big thing that we’re looking for in the markets. You can follow along with that as well. So that’s about it for the second quarter. Just wanted to say thank you for putting a trust in CJM Wealth Advisers. Thanks for hanging in with us during the rocky times in the first quarter. Markets are forward-looking, they usually do tend to rise over time. There are bumps in the road as we saw in the first quarter, and we may see more bumps going forward based upon earning season. But we wish you a very happy summer, a very safe and healthy summer. Thank you.