Maybe near-term consolidation. But longer-term, this secular bull has a ways to run.
It’s been a bit too long since my last memo and a lot—or nothing—has passed, depending on your perspective. The economy has gradually begun to reopen, though increasingly it has become apparent that not all companies/businesses/workers will return to their pre-Covid world. Winners, losers and survivors, to quote an earlier piece, have begun to emerge. The political situation has bounced wildly from “Trump is the favorite” in January to “the Senate will hold Republican” to “a Democratic sweep is coming” to “It’s a toss-up!” This for now puts the race roughly where we’ve seen it heading ever since the coronavirus lockdown dealt a knockdown blow to the president’s booming economy and approval ratings. The Fed has grown increasingly dovish, now effectively promising “lower forever rates,” another development we fortunately foresaw. Although a cure is not yet in, a mosaic of elements have converged to lower the collective fear of this coronavirus, which we’d expected. And with all of the above, the market has ground forward to our longstanding 3,500 target on the S&P 500, originally set with Dec. 31, 2020 in mind and later pushed back into 2021. So, we’ve pulled into the 3,500 station early. The speed of the journey, with its steep late February-late March decline and nearly as rapid ascent, has left us all a little shocked, but the good news is we’ve arrived. More or less, in one piece.
The obvious next question is, “Now what?”
As usual, it’s easier for me to answer this question with a 1- to 3-year horizon than a 1- to 3-month horizon—or worse, a “now” horizon. On a 1- to 3-year view, we see the secular bull, having survived this coronovirus, as roaring ahead, with station stops at 3,800, 4,500 and eventually somewhere above 5,000. All the key drivers of the bull that we’ve spoken of in the past have been reinforced and strengthened, and we think on a long view, very little can upend that. Nearer term, of course, there remain risks and worries, and even we bulls can see them. Net net, we are remaining modestly overweight equities going into the back end of the year, and have taken further profits on our longstanding bet on U.S. growth stocks, rotating last month into a modest overweight to value and international names. Above all, we remain highly selective and focused on picking the right stocks rather than the right markets.
Drivers of the secular bull hit the gas
As much pain as this crisis has caused, it has spawned longer-term benefits, too. The digitization of the global economy has shifted into hyper drive, with lockdowns, remote work and social distancing speeding development, use and refinement of a range of information technologies. Live video chats and meetings, streamed movies and TV series, virtual classes and online shopping for everything from essentials to clothes, appliances, even luxuries small (a favorite Cabernet) and large (a car) are becoming commonplace in our everyday lives. On the medical front, the race to develop a vaccine, rapid tests and effective Covid treatments are spawning a new wave of innovations. Short of workers, their supply chains disrupted by the virus and ongoing trade disputes, manufacturers are finding more efficient ways to produce, bringing work back home from overseas and investing in new plants and equipment—there’s been a sharp recovery in core capital expenditures of late. Layered over this is the all-in Fed and unprecedented peacetime fiscal stimulus. Whether Trump or Biden, look for this to continue—the Fed for sure and, fiscally, either on the supply side (tax cuts) with Republicans or the demand side (more spending) with Democrats. All of this is bullish, as is the retail investor who continues to favor bonds over equities; as the environment stabilizes these underinvested players should gradually enter the market, fueling the ongoing rally for years ahead.
Near-term worry list as high as usual (and that’s OK)
In the very near term, worries and uncertainties abound. Covid’s shadow looms the darkest. While deaths continue to trend down, the number of cases initially climbed this summer among those states rolling back lockdowns, and with colleges restarting and the cooler fall weather coming, case volumes nationwide seem likely to turn up. But so far, death rates have been slowing, implying that some combination of the types of people getting infected, improved distancing protocols and better treatment regimens are making Covid less fear-inspiring, even before the promised vaccine wave begins to come ashore later this year. All of this reduces the likelihood of a second full economic shutdown, but markets can’t completely rule this out just yet. Rising social tensions around the country, especially in our all-important big cities, is another worry to investors and one that seems likely to be with us for some time to come. These tensions will probably be exacerbated by the intensifying presidential race and the increasing likelihood that a messy mail-in balloting system in a tight race will lead to recounts and political uncertainties well past Nov. 3. The economic restructuring process, though long-term positive, seems to be accelerating as the summer slips away, with layoff announcements rising and initial unemployment claims no longer falling as rapidly as they were earlier in the recovery; this could get worse before it gets better. And some investors continue to fret that with the Fed on the sidelines, inflation rates could begin to turn up, pushing up yields on the 10-year Treasury bond, the benchmark discount rate for valuing stocks.
Cautiously bullish, with a tilt toward value and international
With the S&P already at our longstanding target and the Nasdaq climbing almost daily to new highs, the market at some point is going to have to catch its breath. September seasonality historically is the worst of the year, and coming as it is in the middle of divisive election year, some consolidation and a short-term pullback wouldn’t surprise despite the market’s longer-term positive setup. Thus, as reflected in the aforementioned moves we made last month in our PRISM® stock-bond model, we have finally shifted to neutral in growth stocks after their strong run and have added to value stocks, especially small-cap ones, where valuations comparatively are much lower and opportunities arguably are stronger. For a similar reason, we favor adding exposure to international equities, where the performance has been weaker relative to the U.S. and where data suggest a rebound in economic growth is starting to build. Within these modest positioning adjustments, we continue to take most of our portfolio risk at the stock level, where the winners, losers and survivors game continues to play out, favoring stock-picking above all else.
And so now, to answer the question we started with, and paraphrasing John Milton, we simply “stand and wait.”