Fundamentals improving
There are some glimmers of fundamental rationale behind the market’s strength. The jobs market has enjoyed a surprising recovery with weekly initial jobless claims falling from a shocking level of nearly 7 million to 870,000 currently. Meanwhile the unemployment rate has fallen from nearly 15% to 7.9% in only four months. Unfortunately, lower skilled jobs, especially in many service-oriented industries are not coming back nearly as fast.
The housing market hasn’t missed a beat during the pandemic, while industrial production and manufacturing are showing signs of a strong recovery. Manufacturing, especially in new order statistics, has recovered somewhat from the 1st quarter economic shutdown. Sentiment indicators, such as consumer confidence, also are showing real signs of improvement, in line with the improving jobs environment.
Much of the recovery has been driven by the extreme monetary policy response of the Federal Reserve (Fed) and the fiscal emergency funding from congressional action. In the very near term, this recovery could be stalled if Congress is not able to pass continuing financial relief for still-struggling citizens, businesses (especially small businesses), and state and local governments. Unfortunately, this relief legislation is running into the challenging realities of partisan politics very close to a presidential election.
Key market factors
In this environment, the coronavirus infection level – and its impact on the health care system, consumer confidence and politics – is paramount. This remains the major factor in establishing a durable economic recovery.
Fed policy remains a bulwark of support to the market. Exceptionally low rates, and Fed intervention in the bond market remains a very powerful force in not only supporting the economy but driving stock prices higher. It is clear from the Fed’s public pronouncements that this policy is not changing anytime soon.
One longer term issue which bears watching is inflation. Pockets of meaningful price increases are starting to become evident. However, inflation concerns really become more of a problem when wages start moving up. Given the relatively weak level of the employment situation, this is not a near term issue. Longer term, higher inflation risk could lead to some market reaction that would require some portfolio re-orientation.
Corporate earnings collectively were a positive surprise from the 2nd quarter, although this was due to the exceptional earnings of companies that were “winners” in the lockdown environment.
The election remains a messy wild card. Longer term it is not helpful to let the emotion that surrounds politics influence long-term strategic investment decisions. However, the outcome of the election could have near term implications for sector allocations. Upon the outcome of the election, it will be important to evaluate potential tax, regulation and fiscal policy initiatives. Not only will these factors have a potential near-term impact on the markets, but more importantly, they may require a careful review of an individual’s financial plan.
Looking out to the 4th quarter
The 4th quarter could be volatile, particularly after such a strong market surge from the depressed levels of March. We have already seen some market volatility late in the 3rd quarter. Stock market valuation is high, but can be justified by exceptionally low interest rates, full-out monetary policy support from the Fed and possibly another pending dose of fiscal support from Congress. The upcoming election certainly could add to this volatility, as could changing dynamics in the battle against COVID-19.
Interest rates remain exceptionally low, resulting in real yields (adjusted for inflation) that are negative. With long term rates so low, bond return expectations are uninspiring. While the future of both equity and fixed income markets remain cloudy, individual investors should remain committed to a well-thought-out, long-term approach to your portfolio.
