Leon Mehl

Monetary policy decisions have worked out favorably since the start  of  the  pandemic.  Capital  was  made  cheap  for  those  in  need of it and returns became scarce, requiring capital holders to look for return in riskier places. Money in circulation soared in the second quarter as a result of the monetary policy decisions. Confidence is up in capital markets allowing for smooth stock and bond operations. The next transition is to get excess cash reserves off of institutional balance sheets and into the hands of people on main street.

Still, world production has started to increase as the economic lockdowns have begun to lift. Latest data would indicate that the Chinese economy is already in an expansion. Production in the US is accelerating after coming out of lockdown, but more time is needed before things return to capacity. Finding ways to  stimulate  demand  will  ultimately  be  the  way  to  produce  change in the economy. In the meantime, government stimulus is helping to bridge the gap between supply and demand.

Unemployment  stimulus  is  likely  trickling  into  the  economy.  Personal  expenditures  of  households  grew  in  May  while  the  personal savings rate fell. That is a complete reversal of the picture that  was  presented  in  April.  Personal  incomes  experienced  a  decline in May and with 19.5 million unemployment claims still in  the  system,  future  trends  in  household  incomes  will  remain  an  important  topic.  The  special  unemployment  benefits  that  came through the CARES Act are set to expire in July. Without new legislation from Congress, millions could see their income drop.  Another  potential  is  for  more  rising  unemployment  caused  by  state  and  local  jurisdictions  that  are  burdened  by  widening  budget  deficits.

Layoffs  of  government  employees  may be one solution to help close deficits. The  magnitude  of  monetary  stimulus  in  the  economy  has  reignited the debate on inflation. Government debt markets are pricing  in  growing  inflation  expectations  in  the  coming  years.  This has caused the real yield on inflation protected securities to move deeper into negative territory and has steepened the yield  curve.  Monetary  policy  may  not  be  the  only  reason  for  inflation, though.

Even   though   it   is   not   an   official   role   of   a   central   bank,   engineering  financial  liquidity  with  interest  rate  controls  and  asset  purchases  has  helped  stabilize  capital  flows  in  financial  markets. By stabilizing capital markets, corporations were able to accelerate their issues of new corporate debt and raise the capital  needed  in  order  to  survive  a  crisis.  Corporate  debt  as  a  percent  of  GDP  has  ballooned  since  then.  One  way  to  deleverage  an  economy  when  things  get  better  is  to  create  inflation.  Debt  is  devalued  when  inflation  exists  and  leverage  rates naturally begin to decline.

Maintaining  a  functional  market  system  has  also  indirectly  benefited investors. Broad averages of stocks and bonds have recaptured  a  significant  portion  of  their  losses  since  March.  Some  fear  that  stock  markets  are  too  far  ahead  given  the  current stage that the economy is in. But monetary policy has intentionally forced rates-of-return down to make risk-taking a requirement for earning returns. Although it may appear there is a high price-multiple being paid to own stocks, it is important to  recognize  that  other  competing  interest  rate  markets  are  near historic lows. Still, risk is added when yield or some level of return is reached for.

There is no doubt that plenty of systemic risk still lurks beneath the   surface.   Households   face   income   uncertainties   and   corporate insolvency is now present in some highly leveraged industries. The focus of central banking policy is likely to drive down  unemployment  in  the  coming  years  and  may  cause  inflation to run. At least in the meantime, the design to drive down borrowing costs is favorable to mortgage borrowers and other consumers who are able to use lending.

US Stocks advanced for another month in the  broad  category  averages.  Sentiment  for  risk  improved  in  June  to  cause  small-caps to lead in terms of performance. The small-cap    category    average    produced    returns  of  2.6%  versus  large-caps  which  did  1.6%.  In  the  current  year,  however,  small-caps  significantly  lag  behind  large-caps with respective returns of -16.9% and -5.5%.

Foreign  Bonds  strengthened  in  the  latest  month  to  deliver  an  average  return  of  2.3%.  World  bonds  made  another  month  of gains as stimulus rode through to push yields  lower.  The  World  bond  category  average  returned  1.4%  in  the  month  and  0.6%  since  January.  Last  month’s  strength  was   in   emerging-market   bonds.   That   category  average’s  return  was  3.17%  in  June  and  year-to-date  losses  narrowed  to  -4.0%.

Foreign  Stocks  were  one  of  the  better  performing pieces of a diversified portfolio in  June.  In  aggregate,  the  monthly  return  averaged  4.3%,  which  was  ahead  of  US  stocks.   The   current   year’s   performance   divide  between  foreign  and  US  actually  shows  better  on  the  foreign  side,  which  has  not  been  the  case  for  some  time.  Emerging-markets      largely      advanced      in  June  with  a  7.0%  return.  Total  losses  since  January  now  land  around  -9.8%  in  emerging-markets, actually outperforming US small companies.

Hard Assets made modest average returns in   the   month.   The   composite   monthly   average of 1.9% was asymmetrically spread around  in  various  assets.  Precious  metals  did the best with a return of 7.0% in June. Limited-partnerships, linked to energy, did poorly by posting a -4.7% loss. Real-estate assets  returned  about  2.5%  in  the  latest  month. Precious metals are far ahead since January, with 2020 returns now at 18.1%.

US  Bonds  continued  to  capture  returns  in  the  latest  month.  The  aggregate  average  rose 1.0% in the month. Corporate bonds led  in  June.  Investors  in  government  and  corporate  bond  have  held  on  to  gains  since January. Investors in corporate high-yield  and  bank  loans  have  yet  to  fully  recoup their losses of the current year. The riskier bond market category averages are closer to -5.0% in 2020.

Hybrids     continue     to     exhibit     their     robustness  alongside  US  equity  markets.  The    correlation    between    convertible    bonds  and  the  growth  sectors  of  the  US  stock  market  is  working  out  for  investors  in  convertibles.  The  convertible  category  average  returned  4.2%  in  June  bringing  its  return  up  to  7.1%  since  January.  The  concentrated  financial  sector  in  preferred  stocks has been a drag on the average of hybrids.  Respective  monthly  and  year-to-date  returns  in  preferred  stock  are  0.2%  and -7.8%.