Monetary and fiscal policy may have buoyed the U.S. stock market. There has also been some optimism about finding a vaccine for the Coronavirus. Increased testing and fewer deaths have encouraged states to initiate economic opening measures, albeit at a slow pace. Offsetting this optimism is the reality of 20% unemployment, some of which will become permanent even as the economy starts up again. Rent and mortgage forbearance will end. The $1,200 checks will have been spent. China tensions have increased (perhaps for long-term benefit). And shortly there will be election uncertainty.
Elevated valuations. As stocks rallied more than 30% off the March 23 lows and earnings expectations were cut dramatically, stock valuations have become a concern for many investors—including some high-profile hedge fund managers quoted in the financial press. The forward (next 12 months) price-to-earnings (PE) multiple for the S&P 500 Index recently eclipsed 20, which is considered overvalued based on historical averages and is at the highest level since the technology bubble in the late 1990s and early 2000s.
Valuation fears may be exaggerated if we get a steady earnings recovery beginning later this year. Low interest rates and low inflation have often been associated with higher valuations, and valuations are not particularly good at predicting where stocks will go over the near term. Many companies are forgoing guidance in this uncertain environment. Forward price earnings multiples may be meaningless if earnings projections are mere guesses.
Federal Reserve. Fed Chairman Powell’s outlook for the economy, based on his May 13 comments, hardly inspired confidence, but he did not tell investors anything they did not already know. He has also said that the Fed has more tools available and is ready to use them (potentially expanding lending facilities or asset purchases). The market reacted very favorably to those comments. The US economy is contracting sharply, the recovery may be tricky, and more fiscal policy support from Congress may be needed. There is a political contest as to what form the next round of government spending will take. It will probably be large and go well into next year, no matter who wins the presidential election.
Powell also threw some cold water on the idea of negative interest rates, something the European Central Bank and Bank of Japan have undertaken to provide more support for their financial systems and economies. The potential unintended consequences of negative interest rates continue to concern the Fed. While Powell may have eschewed negative interest rates, it is worth noting that the fed funds futures market has briefly priced them in for next year.
US-China relations. Rhetoric from the White House on China has become tougher in recent weeks. Anti-China sentiment has become more of a bipartisan issue as many Americans are unhappy with China’s response to the COVID-19 outbreak, not to mention the question of whether China could have prevented the virus from spreading in the first place. If the Trump administration thinks taking a tough approach with China may help secure votes in November, then we may see more market volatility around the issue. From an economic perspective, tariffs may be a very unlikely tool for retaliation against China with such a weak US economy, but markets might get jittery if it looks like the United States may pull out of the trade deal signed with China in January. It is more likely we may see the Trump administration push harder for domestic companies to bring their supply chains back to the United States from international locations. Investment spending would eventually rise, but so would inflation.
Gold has been a solid performer in this uncertain market, up more than 12% year to date versus the S&P 500 Index, which is down about 10%. We recommend gold as a potential hedge in a well-diversified portfolio for suitable investors.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by LPL Financial, Bespoke Investment Group, Factset.
- All investing involves risk including loss of principal.
- All indices are unmanaged and cannot be invested into directly.