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“This time is different” … or is it?

Jul 2020
Julianna Donovan

While most of the Walt Disney Company’s theme parks remained closed during the second quarter of 2020, global stock markets experienced the rollercoaster ride of a lifetime. In the U.S., the S&P  500 Index increased 20%+ (price plus dividends) during the quarter, rising nearly 40% from the March 23rd low. While now down 3% year-to-date and 8% below the February 19th high of 3,394, memories of the breathtaking 34% decline during the first quarter are quite fresh in our minds. Outside the U.S., the second quarter story was similar, though less dramatic on the upside. Global stock prices, as measured
by the MSCI All Country Worldwide Ex-U.S. Index, increased 16%, ending the quarter down 11% on a year-to-date basis.

The growing divide between Wall Street and Main Street, which is very much still reeling from the coronavirus-induced global recession, geopolitical turmoil, and civil rights unrest, cannot help but leave investors wondering what is in store for the markets in the coming months. The bear case outlook for stocks is quite obvious. Unemployment has spiked to a historic high and residential mortgage delinquencies have risen to levels not seen since 2010. The Federal Reserve is continuously ringing the alarm bells based on what it is seeing in macroeconomic indicators. It has signaled interest rates are likely to remain at current near-zero levels for years, and while some investors welcome this dovishness, the Fed’s “all in” stance underscores the perils of the current economic situation.

Earnings for the S&P 500 index fell nearly 15% in the first quarter of 2020. Consensus estimates now call for a 43% decrease in the second quarter and a whopping 21% decrease for the full year 2020. Against this unprecedented backdrop, it is easy to conclude the stock market is overvalued as it sits at a lofty valuation of 25x 2020 earnings.

While we fully acknowledge the potential for a near-term selloff
driven by a number of potential catalysts, including a second wave of COVID-19, escalating geopolitical
tensions, the upcoming presidential election, and persistent social unrest, we also see a clear – albeit less obvious – bull case for stocks moving forward.

Let’s consider the previously mentioned reasons supporting the bear case in a different light. Yes, unemployment has spiked to an historic high, but recent jobs data has surprised to the upside and both consumer balance sheets and sentiment were healthy before the pandemic. The United States economy is opening up again, and the trajectory, at least on a sequential basis, is clearly positive. Lenders are making significant efforts to work with homeowners temporarily unable to make their mortgage payments. Banks are also in much better shape than they were during the financial crisis. With the economy reopening, the path towards a recovering U.S. consumer – a driving force behind the country’s
economy – is taking shape.

Finally, the Fed is doing everything it can and then some to support the economy. While potentially inflationary and negative for the U.S. dollar, Fed action is bullish for risk assets, including stock prices. As the old market adage warns, “Don’t fight the Fed.” Such advice is worth noting right now.

Regarding corporate profits, which remain under significant pressure, the pace of a potential recovery is more the focus than the damage that has already been done. As we have pointed out in prior editions of our Economic and Market Commentary, the stock market is a leading indicator. With three sequential months of back-to-back gains, the market seems to be signaling that the green shoots we are starting to see as the country begins to reopen will lead to better days ahead – even with the prospect of additional flare-ups in coronavirus cases. As another old market adage warns, “Don’t fight the tape.” More wisdom to keep in mind as cash levels on the sidelines waiting to be invested also sit at historic highs.

Finally, while valuations appear stretched, one could just as easily say looking through the current
turmoil. With underlying macro fundamentals improving on a sequential basis, the market could simply be discounting times ahead when earnings have recovered and the likelihood of increasingly effective treatments and a vaccine will help the U.S. economy continue to regain ground lost so quickly and viciously over the last few months.

We take solace in the fact that we are not trying to call near-term market moves. We are long-term
focused as that is where we believe our clients stand to win – by focusing on and investing for the long-term. We see many reasons to be constructive on humankind, continued advancements in science and
technology, and the long-term health of global economies.

 

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