While stocks suffered the fastest move into a bear market in history earlier this year, that decline was followed by one of the strongest rebounds ever. The S&P 500 rose 44% from the March low through the early June peak. In the second quarter alone, stocks returned about 20%, which was the best quarterly gain since 1998. Incredibly, this left US stocks down just 3% for the year through June and global markets with a loss of 6%, including dividends.
So, what do we make of the disconnect? At the top of the list is the enormous monetary and fiscal response, which has helped plug some of the holes left by the severe economic dislocations caused by the pandemic. In fact, due to government assistance programs, such as the CARES Act, total disposable income in recent months has actually been higher than that preceding the COVID-19 outbreak. The extreme monetary support has also vastly improved market conditions, allowing companies to tap the debt markets at a record clip to fortify balance sheets.
Moreover, a disconnect at inflection points is typical. Stocks tend to look forward, even while the economic data remains weak, rising on average about five months before the recession is over.
Stocks have also been supported by the lack of compelling investment alternatives with interest rates near record lows. Additionally, investors have been somewhat rational in distinguishing between areas that have been less impacted by the COVID-19 outbreak, such as technology and healthcare, where earnings are near record levels, and other sectors, such as energy and industrials, where profits are down dramatically and share prices remain well below prior peaks.
Entering the second half of the year, investors are still faced with many challenges given the uncertain path of the economy and coronavirus, escalating US-China tensions and the US election. This will likely add to market volatility and periodic setbacks.
More recently, stocks have held up well despite the uptick in coronavirus cases and pauses in economic re-openings in some states. Markets, so far, appear more focused on the coronavirus death rates, which have not increased as dramatically, and the promise of vaccines, which are progressing in clinical trials. Never in history, arguably, has there been such a singular focus, involving a huge influx of global resources, on devising a solution to a problem. The news flow on this front and the results of a multitude of trials—even if some miss expectations—should help buffer the market and offset some of the fits and starts in the economy.
Potential changes in Washington will come into focus and will inject volatility into markets, but we urge investors not to look at this in a vacuum.
Elections matter, but the business cycle also matters, as do valuations, geopolitics, monetary policy, and other factors, including the path of the coronavirus and progress toward a vaccine. Moreover, markets have presented investment opportunities and risks under both parties.
While the range of potential outcomes remains wide, our work suggests this bull market continues to earn the benefit of the doubt, and we retain a positive 12-month outlook. The economic reopening process will remain uneven, but the trajectory should be one of improvement and stocks tend to rise during recovery periods. Monetary and fiscal policy should remain supportive. Absolute valuation metrics remain elevated, but relative valuations remain in stocks’ favor. And the price momentum witnessed since late March is consistent with what has typically been seen following important market lows.
Against this backdrop, we are maintaining an overall equity bias. We are also sticking with our US equity overweight, which tends to outperform during periods of heightened uncertainty relative to global markets, and a modest growth tilt where sector leadership remains intact. We continue to expect sharp, periodic rallies in the value style, but for sustainable outperformance, a stronger economy and higher interest rates are likely needed.
While yields are not attractive, high quality fixed income should continue to provide ballast to portfolios during the periodic setbacks we expect. We still see some value within credit markets, albeit diminished from recent months. Finally, a disciplined rebalancing strategy should continue to help investors cope with, and take advantage of, extremes in the market. We saw that in March, when sentiment became overly pessimistic during the decline, and in early June, when sentiment became overly optimistic following a blowout jobs report.
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