Back in January many believed 2020 would be a mostly non-eventful year. The expectations for stocks called for a steady gain in the first half with volatility to pick up in the second half as all eyes and ears turned toward the presidential election. How we’d all like to go back to such simpler times! Since then we’ve only witnessed the catastrophe of a global pandemic, a global recession manufactured as a response to the quick spread of the deadly virus, mass political unrest and demands for sweeping reform, a steep bear market in equities and finally a sharp bounce back for stocks amidst some of the worst economic reports since the Great Depression.
It is no wonder then that institutional investors, retail investors, and the corporations they invest in have a more tepid view of the next six months to a year. There are plenty of reasons to be increasingly cautious, almost bearish, heading into the second act, but so too are there reasons to remain optimistic and take a more bullish stance toward equities in the months ahead. The following are several reasons to remain cautious, or remain bullish, as we head into the third quarter.
Remain Cautious: Coronavirus’ Second Wave
As the US economy begins to reopen after being shut down for several months, and as people emerge from their homes and take the initial steps toward returning to normalcy, we must stay vigilant and consider the potential of a severe second wave of infections and deaths. There is still no widely available and proven therapeutic to reduce the risk of death. Most importantly, there is no vaccine. If we see more cases popping up, especially in densely populated urban centers and/or those areas previously affected (NYC), it would not be difficult to imagine state governors shutting down their states once again, miring the US economy further into a recession from which we seem to be slowly clawing back.
Remain Bullish: Vaccine
A vaccine would not only be the antidote for the Coronavirus pandemic but also the US and global economy. The US consumer makes up approximately 70% of our GDP. With so many people out of work, or not traveling/spending/shopping/eating out, that in turn affects many other lives. A proven vaccine would be a huge boon for the stock market and economy. Even if it were not widely available until early 2021, sentiment is key to restarting the bull market.
Remain Cautious: US Economy
While the US Economy tries to bounce back from a near complete shutdown, there is still much recovery left, making the prospects of a V-shape recovery less likely. Unemployment is still high at 13.3% and GDP is negative (Q1 -4.8%), indicating the likely potential we are in a serious recession. While the recession may have been manufactured by actions to stem the curve of the virus, getting back to normal may take longer than anticipated. Without positive developments on the medical front, we may be in limbo for some time with growth stalled until the entire economy is operating on all cylinders again.
Remain Bullish: The CARES Act and The Fed/Interest Rates
While the economy is feeling the pain associated with the shutdown, Congress and the Fed have signaled they will do anything and everything in their power to keep the economy afloat. This dedication has helped to alleviate concerns for investors and is partially responsible for the strong bounce in the market since March 23rd. The Fed has guided rates to historic lows and indicated it will keep them there for the foreseeable future, providing massive stimulus to all users of credit. Additionally, it has provided multiples of the stimulus made available during the 2008-2009 Financial crisis, buying not just Treasuries but even corporate debt. Congress meanwhile has passed the CARES Act, which has provided $1,200 checks to eligible individuals and interest free, forgivable loans to small businesses, albeit with certain requirements. If our elected officials continue to backstop the economy and the general public, the stock market should continue to focus on the potential for a brighter future.
Remain Cautious: Valuations
Since March 23rd, the market is up nearly 40% (as of June 23rd), even as companies remove their fiscal year guidance. With such dismal expectations for the next 12 months and the S&P 500 down only 8% from its high on February 19th, valuations appear stretched at more than 23 times forward earnings. At these levels, it stands to reason that we should see a pullback in the broader market, as many believe these prices cannot be sustainable.
Remain Bullish: Valuations
Valuations can also point to why an investor may stay bullish on equities. First, although the S&P 500 is well above its historical 16 times price-to-earning average, a look at the underlying companies paints a different picture. There remain many sectors that are still well below their pre-Covid levels, specifically Financials, Energy and Industrials. Additionally, other areas of the market have also yet to reach their previous high-water mark, such as small caps and value stocks. While loading up on any one company or sector is not recommended, there are plenty of opportunities in the market to invest in companies without paying an arm and a leg.
Additionally, when considering valuations, it is important to consider other factors, such as interest rates and inflation. When considering the environment of low rates and low/stable inflation, the market is only slightly overvalued. In such environments going back to World War II, the price-to-earnings ratio has averaged 22 times, only slightly below current levels.
Unlike the famous Robert Frost poem, many more than two roads lie before investors as we head into the second half of what has been a very volatile year. Whether you have extreme trepidation with what is to come, or you believe this could be one of the best six-month periods on record, the smart investor assesses the risks of the potential outcomes and plans accordingly. It is important to build a portfolio with the right asset mix to weather bouts of volatility while also being able to take advantage of broad market rallies. Coming up with a balanced long-term allocation is step one – sticking to the plan and rebalancing are the important next steps to ensure long term investing success.
Note: Fritz Schoenhut is Managing Director and Portfolio Manager at Point View Wealth Management.
Point View Wealth Management is an SEC-registered investment adviser and part of Peapack Private Wealth Management. For over 25 years, Point View Wealth Management has been providing customized portfolio management services and comprehensive financial planning solutions for individuals and their families to develop and achieve their financial goals.
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