GUEST BLOG / By Nela Richardson, Edward Jones Investment Strategist-- S&P 500 advanced for the fourth straight week, with technology stocks leading the index to a new record high. Economic data and corporate profits released last week showed that the recovery is progressing, yet it remains uneven.
Existing-home sales rose by the most on record in July, boosted by low mortgage rates and low inventory. A few big-box retailers that reported second-quarter results saw profits surge during the pandemic. While these are clear pockets of strength supporting the economy and the market, unemployment remains elevated, highlighting the need for another fiscal package.
We believe appropriate balance and diversification can help prepare portfolios for any uptick in market volatility while also positioning them for the longer-term recovery.
This week the S&P 500 edged passed its pre-pandemic record high reached in February. It was a milestone that marks the round trip rally from lows to highs as the fastest bear-market plunge and the second-fastest bear-market recovery in U.S. history.
In contrast, the economy has not had a chance to recover as swiftly from the plunge in economic activity in the second quarter as a result of the pandemic and the national and global lockdown measures to contain it. The good news is that after the greatest decline in economic activity since the Great Depression in the second quarter the economy has shown signs of recovery. The bad news is that with COVID-19 cases still at elevated levels, the momentum of that rebound has softened in August.
So as the markets reach a new high, and as the economy continues to struggle, what’s the bottom line for investors? Here are three points that can inform how we view the recovery.
As markets reach a new high, the economic view is a lot different.
A look back at previous bear markets since 1956 indicates that it typically takes four years on average for stocks to recover from a trough to a new record high. Last week, the S&P 500 reached a fresh high in a mere six months after the March low. Though the S&P 500 levels in February and August are similar, the corporate and economic fundamentals that drive stock returns are quite different, as shown in the table below.
On the corporate front, even the better-than-expected second-quarter earnings season couldn't offset corporate profits dropping 40% from a year ago as a result of the COVID-19 lockdown of the economy. Over the next 12 months analysts expect earnings of the S&P 500 to drop by 14.5% to $153 per share.
Additionally, the bond market looks different, too. Rates that were already low in February have declined even further as the Federal Reserve cut the federal funds rate to near zero and purchased Treasury and corporate bonds to support the economy. Economic indicators, like inflation and consumer confidence, have softened, as restrictions to economic activity due to efforts to contain coronavirus-infection rates continue to suppress consumer demand. On the supply side, industrial production, which includes manufacturing utilities and mining, is improving but is still below pre-pandemic levels, as factories continue to recover from forced shutdowns in February.
The economic recovery is likely to be uneven.
Not every part of the economy is below pre-pandemic levels. Record-low mortgage interest rates (thank you, Fed) have kept demand for homeownership rising, even during the recession.
Two reports released last week captured the strength of the housing market in the midst of an ongoing health crisis. Firstly, existing home sales surged nearly 25% in July from June, the strongest monthly gain on record, according to the National Association of Realtors. Secondly, construction of new homes (housing starts) are up 23% from a year ago, marking the fifth straight month of gains. Home prices are up, too. With 20% fewer homes on the market this year than last year, existing home prices are up 8.5% on the typical home from a year ago, making for the highest median sales price on record at $304,000. And due to lumber mills having been shut down in the spring, the cost of the average new home has surged by over $14,000 since April, according to the National Association of Homebuilders.
The housing market stands in contrast to the jobs market, which was the bright spot in the economy during the February market high. Over the past six months the unemployment rate has surged from a 50-year low of 3.5% to 14.7%, before improving to 10.2%. While we expect continued improvement in the labor market, there are signs that some of the earlier momentum has slowed.
After falling below the one-million mark the previous week for the first time since the onslaught of the pandemic, the number of weekly jobless claims rose again last week to 1.1 million. As evidenced by the contrasting views of the housing and jobs markets, we believe that while some sectors of the economy have prospered, others are dependent on continued fiscal support, at least in the short term.
Don't let elections obstruct your view of what drives portfolios over time.
Last week, the election news cycle kicked into full gear with the Democratic National Convention (held virtually for the first time). Next week, the Republican National Convention will take center stage. We expect election news will dominate headlines through November, and election uncertainty may cause short-lived market volatility.
However, we also note that stocks have performed well in all types of political configurations, returning 10% on average over the past 100 years regardless of which party occupied the White house or controlled Congress (or any combination of the two). What matters more for investor portfolios over the long term are economic and corporate fundamentals that support the rise in stock prices over time. Federal stimulus has been key in helping low-income households that were most vulnerable to the COVID-19 lockdown to stay financially afloat through direct payments, extended unemployment insurance benefits, and moratoriums on mortgage delinquencies and evictions.
Moreover, fiscal stimulus has been a key support for the 55% rise in stock prices over the past six months1. As Congress continues to jockey over how much and what type of stimulus is still needed, we think continued fiscal relief in some form can help mitigate the hardships vulnerable households could face in coming weeks and make the economic recovery more sustainable in the second half of the year.
The bottom line for investors
A new record high can't erase all the risks to the economy of the biggest health emergency in 100 years. However, the rebound in equities, and the support of bonds by lowering these risks in investor portfolios, does demonstrate the importance of keeping a long-term view when it comes to your investments. Working with your financial advisor can help you stay focused on an investment strategy that can help you reach your long-term financial goals in all types of market (and political) environments.
SOURCES: EDWARD JONES, BLOOMBERG.
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