Where to from Here for Equities?
There will be two very important events in coming months. The CARES package will expire at the end of July, and Fed support programs at the end of September.
As for the election, we continue to believe it is too early to call the final outcome.
As the economy began to reopen in May, spending recovered and the savings cushion was lowered.
Earnings season so far has not been as bad as anticipated, with the majority of companies modestly beating reduced expectations.
While efforts are being fast-tracked, ultimate acceptance by society will hinge on how robust the process has been, and how safe people feel about getting the vaccine.
After the fastest and sharpest contraction in global economic activity since WWII, financial markets have rebounded sharply, driven by massive stimulus efforts, an easing of governmental lockdowns and progress in the fight against the coronavirus. With equity markets near all-time highs, we believe it is important to look at several critical investment variables that could exert significant influence on the economy and markets for the balance of the year. Broadly speaking, these critical investment variables relate to the government, consumer, corporations and COVID-19.
There will be two very important events in coming months. The CARES package will expire at the end of July, and Fed support programs at the end of September. Headlines in the media will be filled in coming weeks covering what is likely to be a very contentious debate in Washington regarding the overall dollar amount of aid and specific programs. While we are assuming a package will be passed, the timeline is tight, and as we saw in late March, negotiations will likely go down to the wire.
We believe close to $2 trillion more in aid will likely be needed and should include elements to help the consumer, including extending unemployment benefits, though by a lesser amount, and another direct stimulus payment. Many smaller businesses also will need more support to stay open and remain viable for the long term. It’s very damaging for many small businesses to close, reopen and then shut down again. State and local governments, too, are facing increasingly large revenue shortfalls and will need funding to minimize layoffs. Finally, the dollar amounts to support the Fed programs also need to be extended. Whether tax cuts or more dollars will be allocated to support a more cohesive health care response remains to be seen.
As for the election, we continue to believe it is too early to call the final outcome. Democrats have the momentum currently and history shows that incumbents get voted out of office when the economy is not healthy. The proposals by the presumptive Democratic nominee, former Vice President Joe Biden, regarding tax increases do not seem like a wise move to us, given the current state of the economy, and would not be market-friendly. However, at this point, we suspect they may be more election rhetoric than policy reality.
In the near term, consumer confidence and spending will be greatly influenced by the level of support in the next fiscal package. Benefits from the CARES package have undoubtedly bolstered consumer spending recently. One-time stimulus checks and the extra $600 in weekly unemployment benefits have effectively cushioned incomes amid widespread layoffs. In the month of April, it appears most of the benefits went into savings while spending fell. But, as the economy began to reopen in May, spending recovered and the savings cushion was lowered. It’s likely this trend continued in June.
For businesses, the right fiscal programs for job retention and creation, as well as debt and rent forgiveness, could reduce the need for more layoffs. It is encouraging that the reduction in 2020 S&P 500 consensus earnings estimates has bottomed and gone sideways for a few months. Earnings season so far has not been as bad as anticipated, with the majority of companies modestly beating reduced expectations. It is early, and there will likely be some ugly results from industries most exposed to the crisis, but the second quarter will likely mark the trough for earnings.
Looking forward, we are expecting improvements in earnings over the second half of the year and into 2021. While the trajectory still has a wide range of outcomes that will be greatly influenced by the pace of economic activity, a solid fiscal package would be a good thing for confidence in the outlook. Currently, our estimate range for 2021 EPS growth remains quite large, at 20-40%, with a base case of 30%.
The battle to contain the virus, and the tension between public health and the health of the economy, will shape the trajectory of the recovery over the second half of the year. If true behavioral changes regarding wearing masks are occurring, this would make for a stronger and more effective response to the virus, should a second wave hit in the fall.
Positive trial results have raised hopes that a vaccine may soon be available, perhaps even by year-end. It is encouraging that COVID-19 is 80% similar to the SARS virus, and that its DNA has been decoded. The massive amount of money, science and brain power being devoted to developing a vaccine is also good reason to be optimistic. Still, it is premature to project that progress being made in Phase 1 and 2 trials will produce a vaccine that not only triggers a strong immune response, but is also long-lasting. While efforts are being fast-tracked, ultimate acceptance by society will hinge on how robust the process has been, and how safe people feel about getting the vaccine.
Our conclusion is that economic activity in the second half of the year will continue to recover, but will be greatly influenced by these critical investment variables. Equity returns are likely to be moderate, with increased volatility as these variables unfold. We believe we have the right portfolio positioning, focused on high-quality durable assets that withstand uncertainty and minimize risk while also allowing for participation in future gains.