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Wednesday, September 16, 2020


Editor’s Note: As Edward Jones is the financial advisor of this daily online publication, permission is granted to [p2p] to republish certain data to our readership.

REPORT: (SEP. 7 – SEP. 11, 2020)

GUEST BLOG / By Nela Richardson, Edward Jones Investment Strategist--Stocks declined for the second straight week, as technology stocks experienced their worst pullback since March. There was no single catalyst for the move lower, which left the Nasdaq about 10% below its all-time high reached just six trading days ago.

However, broad valuation concerns, skepticism about a compromise on a coronavirus stimulus package before the election, and signs of slowing progress in the labor market all contributed to the negative sentiment. We continue to believe a longer-term recovery is under way, but stocks are likely to enter a more volatile period than the one experienced during the summer months. The path forward could be bumpier and the pace of the recovery slower, and as a result, stocks could start to consolidate some of the recent gains.

Stage 3 of the Recovery
Last week stocks fell 2.5%, posting their second consecutive week of losses1. We don’t think that last week's pullback is a sign that the rally has come to an end. But it does highlight our view that we've reached a bumpier stage in the economic recovery, prompting occasional downward swings in stocks even as the overall rally continues.

Despite the unprecedented, unpredictable and unruly path of the COVID-19 pandemic, we've observed a pattern to the economic recovery to date that we believe can be defined by three distinct stages:
Stage 1: A severe recession
Stage 2: A sharp early rebound
Stage 3: A slow recovery back to pre-pandemic levels.

In Stage 1, with lockdown measures firmly in place in April and May, the economy suffered its greatest economic decline since the Great Depression, the unemployment rate skyrocketed to a record high, inflation plummeted, and corporate earnings sank1. In Stage 2, as the country began to gradually reopen in June, the economy displayed a sharp bounce-back in growth, fueled by strong fiscal stimulus, near-zero interest rates, and unleashed consumer demand. Following this initial bounce in economic activity, we think the recovery will transition to Stage 3, defined by a bumpy road back to pre-pandemic levels of growth. Below are four likely characteristics of this next stage in the economic recovery.

1. The pandemic is still in the driver's seat
The path of the economic recovery will be determined to a great extent by the path of the coronavirus. If new outbreaks of COVID-19 stay localized and contained, the economy can continue its phased reopening. On this front we've seen progress from the high infection rates reached this summer. The seven-day average of new cases has fallen from the peak of over 65,000 cases in late July to under 40,000 as of September 92.

At the same time, the number of new cases seems to be stabilizing at a higher rate than what we saw in early June, when the seven-day average for new cases was under 25,0002. With K-12 schools and colleges and universities now reopened, the path of the virus is even harder to predict than when most people were abiding by stay-at-home orders and schools were closed.

A second wave of new infections that intersects with the traditional flu season could slow down the reopening process in the U.S., making Stage 3 of the economic recovery even more choppy.

Stage 3 Outlook: While the path of the virus remains uncertain, we point to continued progress in testing, treatment and vaccinations, which can lessen the impact of COVID-19 on the economy. We expect progress on the medical front to continue, though a timeline to a widespread distribution of a vaccine will likely not occur until 2021, leaving 2020's economic progress still vulnerable to pandemic outbreaks.

2. It may take several years to return to pre-pandemic levels of economic growth.

Recent economic indicators show solid improvement from the dire economic numbers during the lockdown period of Stage 1, but also reflect slowing momentum than seen in Stage 2. For example, the unemployment rate has improved substantially, from nearly 15% in April to 8.4% in August, but now gains may be more incremental3. The number of jobs created in August rose by 1.4 million, but that's lower than the 1.7m in July and 4.8m in June3. According to the U.S. Congressional Budget Office, the unemployment rate will not drop below 6% until 2024, still substantially higher than the 3.5% level of unemployment in February.

Stage 3 Outlook: We think the still wounded labor market, with 11 million more people out of work than in February; the continued business closures; and the lower productivity and increased costs (tied to safety protocol and capacity constraints for businesses that can reopen) will likely make the return to pre-pandemic levels of growth take longer in Stage 3.
3. Federal stimulus is likely to be smaller in magnitude.

In Stages 1 and 2 of the economic recovery, the amount of fiscal support from Congress was the highest on record at $3.7 trillion, or 16% of GDP (the highest level since 1945). In contrast, this week a renewed effort to pass a smaller fiscal-relief package to hard-hit businesses and households fell short as the Senate failed to pass the so called "skinny bill" that would have provided $650 billion in economic stimulus.

Aggressive stimulus has been an important driver of the economic recovery. Positive indicators of consumer financial-health measures like high savings rates and low debt levels have held up, even with record levels of job losses, due in large part to direct federal payments to households and enhanced unemployment-insurance benefits. Now that many of these benefits have ended, the risk is that consumer spending, which is two-thirds of the economy, will decline again after having rebounded in Stage 2.

Stage 3 Outlook: It is still possible that a deal will be struck that bridges the gap between the Democrat original proposal for $3 trillion in new spending and Republican $1 trillion plan. However, the ongoing stalemate in new stimulus measures threatens to make the already vulnerable recovery in Stage 3 even less robust.

4. The pullbacks in stocks will likely be more frequent.
The S&P 500 dipped to 2.5% last week as the tech stocks took a breather from the relentless rally seen over the past five months1. Despite the recent pullback, tech stocks have led the remarkable market rebound from the March low, with stocks up 2.7% to date and within 7% of the record high that was reached in August and that surpassed even pre-pandemic levels1. Though expectations for the tech sector are high, they are also backed by strong profits, low debt levels, and durable business models. More broadly, we expect earnings, a key driver of stock returns, to continue to improve in the latter part of 2020 and then rebound in 2021.

Stage 3 Outlook: While we do believe that the worse part of COVID-19's impact on the economy is behind us, we also think that the easy part of the recovery is coming to an end. What’s ahead is a slower pace of growth that is uneven across sectors and regions, making the climb in stock prices bumpier than the smooth rise seen this summer.

Because the economic fundamentals supporting the rally are likely to be less vigorous as we move from Stage 2 of the recovery to Stage 3, we expect occasional pullbacks in the equity rally. Maintaining diversification across asset classes, sectors and geographies can help investors reduce the impact of temporary downward swings on long-term portfolio performance within the broader market climb. Despite the bumpier growth path ahead, focusing on achieving financial goals over time rather than on short-lived market moves can help make the economic journey from recession to recovery a smoother ride for investors.

Sources: 1. Morningstar direct 2. CDC 3. US Bureau of Labor and Statistics.

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