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Weekly Investment Commentary: The summer market churn continues
Highlights
- Stock markets saw price gains last week, yet remain within the same broad trading range they have experienced for the last couple of months.
- We continue to believe that the economy will recover over the course of this year, but we are growing more concerned over how rising coronavirus cases are complicating plans to reopen the economy.
- For now, we remain cautious toward stocks, and expect markets to continue churning through the summer.
Despite day-to-day and week-to-week volatility, stocks prices remain little changed over the past couple of months. Last week, the S&P 500 Index rose 1.8% to a level slightly below where it was one month ago.1 Megacap technology stocks led the way, while small caps experienced a loss for the week.1 Sector winners included consumer discretionary, communications services and technology, while energy was the worst-performing area.1 The financial sector also outperformed, ahead of some key earnings results from banks this coming week.1
Weekly top themes
- Escalating coronavirus cases could slow growth. With U.S. daily new cases over the 50,000 mark, officials in many states have halted or reversed plans to reopen economies. We have already seen state-specific declines in consumer spending and jobs growth that could continue into July.
- Second quarter earnings results are going to be horrific, but the bad news has already been priced into the markets. The focus this week will be on large multinational banks, which have been experiencing pressure due to troubled credit markets and low interest rates. For the S&P 500 as a whole, current expectations are for a 45% drop in earnings year-over-year, representing the worst three-month period since the fourth quarter of 2008.2
- The odds of additional fiscal stimulus look better than 50%. We expect something in the $1 trillion to $1.5 trillion level, although it may not pass before the $600 weekly unemployment benefits expire on July 31. The package could include smaller unemployment benefits, more funding for the payroll protection program, direct aid to state and local governments and more help for the health care sector.
- The jobs market is improving, but recovery will take some time. Since the pandemic began, the U.S. has lost 22 million jobs.3 So far, 8 million have been restored over the last two months.3 We think adding 7 to 8 million more jobs before the end of the year is likely.
- Markets are starting to focus on a growing possibility of a Biden presidency. With his standings in the polls improving, Joe Biden last week outlined his $700 billion plan to revitalize the economy. His plan aims to create 5 million new jobs, heavily based on government promoting domestic manufacturing. He also intends to raise corporate tax rates from the current 21% to 28%.
- Growth has continued to outperform value in recent weeks. Much of the relative outperformance can be attributed to megacap technology companies that are benefiting from increased Fed-induced liquidity, as well as concerns over the escalating coronavirus cases and worries over economic growth prospects. Should the economy continue to recover, we think value styles could improve.
- Investors will likely have to contend with more constrained market returns in the coming decade. Over the past 50 years, a 60/40 blend of U.S. stocks and bonds has returned close to 10% per year on average.4 But stocks and bonds are both at the high end of their valuation levels. That suggests that an average annual return of closer to 3% to 4% looks more likely for the next decade.
Three reasons for near-term caution
Over the last couple of months, stocks have been caught between positive and negative crosscurrents. On the positive side, markets have been supported by policy stimulus, hopes for improvement in economic conditions and a lack of appealing alternatives. On the negative side, they are being held back by a growing realization that the economy faces a long road to recovery and worries over a stalling or reversal in growth. At this point, we are concerned that much of the good news has already been baked into asset prices, while the bad news has yet to be fully factored in.
In particular, we point to three near-term concerns. First is the growing uncertainty about coronavirus trends and what they will mean for the economy. Barring a vaccine, cases in the United States will likely continue to grow, both in absolute terms and relative to the rest of the world. Second is the U.S. election. Current odds suggest a Biden victory and a growing possibility of a Democratic sweep of Congress. Should this happen, risk assets and the U.S. dollar would likely come under pressure due to higher corporate taxes and a less equity-friendly regulatory environment. And third is current stock valuations. At present the forward price-to-earnings ratio of the S&P 500 is over 20X, which is quite high.1
“We expect markets to continue to churn, and possibly experience a near-term consolidation since stocks are at the high end of their current trading range.”
At this point, we expect markets to continue to churn, and possibly experience a near-term consolidation since stocks are at the high end of their current trading range. We are likely to retain a cautious outlook toward stocks, unless prices fall to make valuations more attractive or we see greater clarity around the path of the virus and the economy.
1 Source: Bloomberg, Morningstar and FactSet
2 Source: Credit Suisse
3 Source: Bureau of Labor Statistics
4 Source: JP Morgan
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
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The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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