Over the last few weeks, the European Union’s massive fiscal plan and expectations of additional stimulus in the U.S. seems to be effective in raising the hopes of investors. Still, upside in stocks was limited amid continued signs the economic recovery may be stalling – likely due to stalled progress on a widely expected fifth virus relief bill. Looking out a little further, vaccines and treatments for COVID-19 (no one knows when they will be administered to the masses) helped offset a continuation of rising infection rates around the world. With stock valuations reaching unusually elevated levels, we reckon the good news better keep on coming.
Initial jobless claim filings increased from 1.3 million the prior week to 1.4 million. This result was a disappointment and marked the first weekly increase reported since March. The data may be signaling the economy has lost momentum following the solid improvement throughout much of April and May, but we think it’s premature to make such a bold assumption. Bipartisan negotiations out of Washington will lead to a bill supporting the economy and virus response to the tune of $1.5 to $2 trillion (more) by early- to mid-August.
We expected earnings per share to decline by some 40% in the second quarter, but so far earnings have generally exceeded estimates with nearly 30% of S&P 500 companies reporting. We get our first look at real GDP for the second quarter – Government officials suggest something on the order of being down some 30 to 35%. As you might expect, current conditions have sent the U.S. dollar into a technical tailspin. If the greenback continues to slide, U.S. growth and S&P 500 earnings should benefit, but we also run the risk of sparking U.S. inflation.
Looking at the technical, we note, market breadth is the narrowest we’ve seen in 20 years, meaning fewer stocks are participating in rallies. Why is this important? Well, when markets are performing well, most of the listed stocks tend to rise and fall together. Using breadth as a signal of strength or weakness, investors can discern where the market might be headed. Our breadth indicator began to deteriorate noticeably after the early June market high. Over time, we have learned deteriorating breadth is rarely a good sign for the market which leads us to issue a caution against chasing stocks higher.
We are closely monitoring the high concentration of returns in a handful of technology titans, the Fed’s balance sheet, a potential fiscal cliff, and the possibility of a Democratic sweep – none of these headwinds are priced into equities. Gold has risen to near-record levels and seems consistent with an upward trajectory in consumer prices in the coming years. Low productivity growth and, as we mentioned, the decline in U.S. currency may also feed into potentially rising inflation.
From our perspective, bonds and equities look expensive, setting the stage for what we believe will be a period of below-average returns and potentially above-average volatility. The European Union’s (EU) massive fiscal plan combined with expectations of more fiscal stimulus in the U.S. should assuage investor fears until the pandemic recedes. Despite messy politics and the general desire to constrain increasing budget deficits, most policymakers understand that a premature end to fiscal support would risk a political disaster.
Stocks are again trading around 22 times forward earnings, a valuation that leaves little room for bad news. In our opinion, setbacks in fighting the pandemic should be viewed as “when, not if”, but we don’t believe this will derail positive economic trends as businesses continue to reopen. Suffice it to say, however, economic recovery will likely be long and bumpy.