hero july market commentary

Allianz Investment Management LLC July Market Update

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Market outlook: Economic rebound is underway, but how quickly can we recover?

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There isn’t much to discuss regarding first quarter GDP at this juncture since the data is stale and investors are more interested in what the coming months eventually look like. For the third estimate on first quarter GDP, there wasn’t any change as the number was unrevised at -5.0%. In addition, personal consumption, the key to economic growth in the U.S., was unrevised at -6.8%. With the first quarter GDP data behind us, attention has shifted to the second quarter as we try to determine just how bad it was. With the coronavirus lockdowns effectively halting the economy, we know the figure is likely to be terrible. The median estimate from economists on Wall Street indicates that U.S. real GDP declined by almost 35%. This would equate to the deepest recession the U.S. has ever seen, but fortunately the economy is recovering quicker than anticipated and this may turn out to be the shortest recession we have ever seen. Overall, most market participants are looking past the negative data at this point and really trying to assess the strength of the recovery that we are in. For the most part, high frequency data points and labor market data is encouraging, but we continue to see areas of the country battling the virus and certain sectors like airlines and hospitality continue to be depressed. It may take until 2021 to see a better sense of normalcy, but we are quite certain the recovery is underway.

 

INTEREST RATES

Fed policies have left investors little to think about with regards to interest rates. The front end of the curve is anchored quite securely with policy rates near the zero bound, and the rest of the curve has traded in a narrow range over the past month as Fed purchases continued. As virus concerns start to fade and the economy fully recovers, we could see some upward pressure on rates, but bond investors have yet to price that into the equation as Treasury yields have barely moved. Not to mention we have an election coming this fall where the potential for market volatility is high given the uncertainty surrounding the outcome. Therefore, we continue to expect Treasury yields to trade within a narrow range unless we see a substantial change in the economy in either direction.

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Tailwinds turned into headwinds as virus cases threaten the recovery

Against the backdrop of a recovering economy, markets ebbed and flowed throughout June as investors weighed the better-than-expected economic data releases against the rise of COVID-19 virus cases across southern states. Market sentiment shifted toward a more cautious stance last month following gloomy comments from the Fed and a resurgence of coronavirus cases in states like Arizona, California, Texas, and Florida. Both the Texas and Florida governors have decided to shut down restaurants and bars in their respective states in order slow down the spread of the virus. Regardless of the reasoning, most investors would agree that the equity market got a little ahead of itself when considering the rally from the low on March 23. Despite the headwinds from increased coronavirus cases, risk assets ultimately prevailed as broad equity indices tallied another positive gain in the month of June. We suspect there will be a continuation of the fits and starts as the economy continues to open up, but with the bar remaining high for a broader shut down in the country, there is a greater need for the virus and the economy to coexist.

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Better-than-expected labor market conditions provide a solid footing for further recovery

Labor market conditions continue to show signs of improvement as lockdowns come to an end and businesses open back up. Looking at higher frequency data like jobless claims, we took note that employment separations continued to trend in the right direction with weekly claims grinding lower. However, there were some increases in jobless claims in states like Arizona, California, and Florida, where COVID cases have notably picked up. However, in aggregate, claims trended lower as the reopening of businesses in many states offset the increasing claims in the troubled states. Moreover, we continue to see a decline in continuing claims with the latest data showing continuing claims falling below 20 million. Furthermore, the June employment report topped estimates again as the Bureau of Labor Statistics reported 4.76 million jobs were added to the economy in June. The unemployment rate dropped to 11.1% and provided further confirmation that a rebound is well underway and the economy has a solid backdrop for further recovery.

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A shift in consumer sentiment fueled strong retail spending in June

Much of the economic recovery in the U.S. hinges upon the strength of the consumer, and throughout the month of June there were some solid indicators that lead us to believe consumer spending is rebounding. Starting with sentiment, consumer confidence measured by the Conference Board had the largest monthly gain since 2011 with the index rising by 12.2 points to 98.1. Despite being below pre-pandemic levels, the large gain in June is a positive sign that consumers are feeling better about the current and future conditions. Additionally, sentiment measured by the University of Michigan had the biggest monthly gain since 2016 as labor market conditions helped fuel consumer attitudes. As a result, U.S. retail sales rebounded strongly across all categories, rising +17.7% month-over-month, more than double the +8.4% expected. On top of that, the previous month’s decline was revised to a smaller -14.7% contraction (from -16.4%). Autos lifted up the overall number, with vehicles and parts seeing a +44.1% rise in May, but even core sales ex-auto at +12.4% came in stronger than anticipated (+5.5%). Two factors might have helped the strong rebound: the surge in household income in May from stimulus checks, and the restrictions on service consumption prompting a temporary substitution to (retail) goods. Overall, the data on retail sales helps shape the argument that the economy is on the road to recovery.

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Market indicators

Equities and crude oil gained throughout June while Treasury yields remained compressed; volatility slightly elevated due to virus concerns and election uncertainties
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Equities chugged along throughout the month of June as much of the country began to open after the prolonged shutdown. Although virus concerns increased, equities ended the month higher with all three major indices reporting gains month-over-month. Most notably, the NASDAQ increased over 6% in June as the tech sector outperformed the broader index. Overall, market sentiment for equities continues to improve, however, some question whether equities may have rallied too quickly given the economic backdrop and ongoing virus worries. Tech was doing better than the broader index indexes.

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Market volatility, measured by the CBOE VIX Index, returned above 30 in June as surging COVID-19 cases in the South coupled with increased uncertainty surrounding the November election outcome drove investor apprehension. Overall, we expect volatility to be elevated for some time as repercussions from the virus, as well as the election, play out.

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Treasury yields continue to be anchored as purchases from the Fed continue to put downward pressure on yields. With the exception of the long-end of the curve, which declined slightly, the U.S. Treasury curve was mostly unchanged throughout the month of June. Overall, we expect the trend of low yields to continue for the foreseeable future.

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West Texas Intermediate (WTI) crude oil closed just under $40 per barrel at the end of June, marking a gain of $3.83 month-over-month. Going forward, the price and overall recovery of crude oil is going to depend on future implications of the virus and whether economic demand returns. Overall, the energy market continues to work through the supply imbalance resulting from nearly nonexistent demand during the COVID-19 lockdowns.

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Economic indicators

ISM Manufacturing and the June Employment Report came in better than expected while inflation remains muted
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As the initial lockdown measures have been lifted, the ISM manufacturing index suggests that activity has recovered fairly quickly. The index increased significantly to 52.6 in June from its May level of 43.1, indicating an expansion of the overall economy. The biggest contributors were new orders and production sub-indexes, which each rose by roughly 24 points. However, the employment sub-index remained more subdued. Industry commentary turned positive (1.3 positive comments for every one cautious comment), reversing the cautious trend which began in March.

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Inflation was softer than expected for the month of May as both headline and core CPI declined by 0.1%. The story remains the same as it has been in previous months with airfares, hotels and apparel being a large drag on the index. Within core CPI, we also witnessed the same components putting downward pressure on consumer prices. On an annualized basis, headline CPI dropped to 0.1% and core CPI fell by two-tenths of a percent to 1.2%. Overall, the CPI data is in line with recent commentary and projections from the Fed in that inflation is expected to be quite muted for the near-term outlook.

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The June employment report surprised to the upside for the second month in a row with nonfarm payrolls increasing by a whopping 4.76 million. Additionally, the unemployment rate continued its descent last month, falling from 13.3% to 11.1%. While the positive employment data was a welcomed sign that the economy continues to be on the mend, we remain cautiously optimistic going forward as states, specifically in the South, have seen a surge in COVID-19 virus cases recently.

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The market recovery appears to be well under way as economic data throughout the month of June was generally positive for the U.S. as a whole. However, the resurgence of coronavirus cases in the Sun Belt has cast doubts on where we head from here, and the drumbeat from market participants has grown louder and louder for another round of stimulus. Many Fed members, including Chairman Powell, have stressed the fragility of the recovery and reiterated the need for Congress to pass additional fiscal stimulus measures. Looking ahead, we anticipate market participants will have to weigh the risks surrounding the path of the virus as well as the upcoming U.S. election as they navigate volatile markets during the second half of 2020.

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List of definitions

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The views expressed above reflect the views of Allianz Investment Management LLC as of 07/2020. These views may change as the market or other conditions change. This report is not intended and should not be used to provide financial advice and does not address or account for an individual's circumstances. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Allianz Investment Management LLC is a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America.