August 7, 2020
Following the best quarterly gain since 1998, stocks continued to defy skeptics in July as global equities and the S&P 500 each rose more than 5%. This is consistent with the studies we reviewed last month, which showed strong quarterly market returns tend to be followed by additional gains. Notably, the tech-dominated NASDAQ Composite Index is now up 20% for the year and trades at a record high. This is an amazing feat, but the pandemic has served to accelerate many existing secular trends and has allowed the technology sector to thrive during the economic downturn.

Despite a wide range of potential outcomes, the weight of the evidence in our work suggests that we are in a bull market, and perhaps somewhat in an early stage. The extreme selling and negative investor sentiment readings seen at the March low are consistent with a market bottom, as is the strong upward price momentum since then, as the first leg of a bull market tends to be the sharpest. Still, even with the rebound, the S&P 500 remains about 10% below its longer-term price trend.

Although the recent economic downturn has been sharper than anything we have seen since WWII, following the previous 12 worst quarterly declines in gross domestic product (GDP), stocks have been up a year later every time. This reflects the fact that the market tends to look ahead, even while current economic data is still weak. Moreover, we are at the beginning of the economic recovery, even if it is an uneven path forward, and stocks have risen 85% of the time during expansionary periods; notably, the average economic expansion has lasted more than five years.

There is little argument that equity valuations are high on an absolute basis, but they are likely to stay elevated relative to historical averages. Indeed, Federal Reserve (Fed) Chairman Powell recently noted that the Fed was “not even thinking about thinking about raising rates.” This is a powerful statement. The low interest rate environment is set to persist for the foreseeable future, pushing investors seeking higher returns into riskier assets.

The market rise, though, is not only about the Fed. During the current quarterly reporting period, companies are exceeding depressed earnings expectations by the greatest percentage in more than 15 years, and forward profit estimates are rising.

Despite our positive view, there are a number of risks which will likely contribute to periodic market setbacks. The pickup in COVID-related cases is serving to soften some of the improvement in economic and mobility trends. US-China tensions continue to ratchet up. And investors should also be braced for higher market volatility as we move closer to the US elections.

However, we would advise investors not to make wholesale portfolio changes based on the potential election outcome alone. Elections matter, but they should not be viewed in a vacuum from a market standpoint. Historically, there have been opportunities and risks while either party was in power. Moreover, progress towards coronavirus vaccines and therapeutics will likely have a larger impact on the economy and markets over the next year than the outcome of the election.

From a positioning standpoint, we maintain an equity tilt relative to fixed income, especially with government bond yields hovering close to all-time lows. Within equities, we hold a US bias, where earnings trends remain stronger compared to much of the globe. Technical price trends for the international developed markets deteriorated over the past month, with Japan and the United Kingdom making fresh relative price lows.

Conversely, improvement is evident in emerging markets (EM). We are raising our EM outlook by one notch this month, though keeping it below neutral. China, Taiwan, and South Korea—which account for almost two-thirds of the weighting in EM—are showing better earnings and price trends relative to international developed markets. That said, with China accounting for about 40% of the index alone, political uncertainty for EM will remain high through the US elections. Yields are set to stay low, but high-quality fixed income should continue to serve its role as a portfolio stabilizer. Although credit spreads have tightened substantially, investment grade and high yield bonds should remain supported by the Fed and investors’ search for yield.

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