Should I stay or should I go? Stock recovery in Q2

On March 23, no one would have anticipated that we’d have a recovery of the magnitude we’ve seen since then. Of course, we’re inundated with differing opinions about where things will go from here – both positive and negative.

I’m no economist and don’t have a crystal ball telling me where the markets will go, but   I think it’s pertinent to understand  the positives and negatives of remaining invested. Here’s a summary of both sides.

The downside

Let’s start with the negatives. Those who are pessimistic today view the current situation of record-high valuation levels in markets, combined with significant negative economic news, as a defiance of common sense. Their view is that investors have been driven by aggressive central bank actions around the globe that have provided massive liquidity into financial markets which effectively supported stocks. 

One of the biggest surprises is how investors have returned to some of the most speculative sectors, including airlines, cruise and travel companies. With the significant resurgence of Covid-19 cases in the U.S., Latin America and India, combined with the massive negative impact on the global economy in 2020 (and possibly for years to come), why is it that stocks have surged back close to their all-time highs in the U.S.?

The chart below shows the massive expansion of money supply in the U.S. by the Federal Reserve. Many feel that this liquidity is providing the fuel for stock markets and, hence, explains why stocks have risen so sharply since the March lows.

Pessimists see investors buying stocks due to a combination of very low interest rates with “hope” that recovery will be strong. Therefore, in order to sustain the current market levels, we have to see better economic data. The U.S. Market is currently at its highest valuation level since the technology bubble in 2000. Companies will need earnings growth to sustain these valuations.  

The feeling is that stocks have been driven up primarily by retail investors spurred by all of the stimulus cheques they’ve received from the government. Many smaller retail investors tend to buy ETF’s which end up driving all stocks up, whether warranted or not. Prior to the pandemic, the feeling was that stocks were driven by huge corporate buybacks of shares. Now, these buybacks have subsided sharply and have been replaced by retail investor buying.

Record numbers of new retail investors are opening online brokerage accounts to purchase stocks. This enthusiasm has pessimists very concerned, as similar behavior was observed during the technology bubble.   

The pessimistic view is also based on the perception that stocks are trading based on an expected V-shaped recovery, when in fact they feel the economic recovery will be much more prolonged and potentially wide “U” or “W”.

The upside

And now, some positive views that the market recovery is justified. So far, from an economic perspective, the re-opening of economies is going better than expected and as a result, this should lead to sharp recoveries in corporate earnings.

Supporting this theory are much higher-than-expected U.S. job data in May and June. In May, jobs actually increased by 2.5 million compared to expectations that a further 7.5 million jobs would be lost. In June, 4.8 million jobs were created vs an expectation of 2.9 million. That brings the unemployment rate in the U.S. down to 11% – albeit still a ways to go as pre-pandemic unemployment was around 3%.  

Another strong positive has been the resurgence of retail sales, both in the U.S. and Canada. Retail sales in the U.S. were up 18% in mid June vs the prior month. This more than offsets the 14% decline in April and, in fact, retail sales in the U.S. are back at their March levels.

At this rate, over the next month or two, retail sales may in fact exceed their January and February pre-COVID peaks. Online shopping and retail food sales remain big winners, as do home improvement stores due to more people staying at home. Manufacturing data in the U.S. and Canada is also coming in better than expected. We’re also seeing sharp improvements in new home sales in the US. It appears that Canada is not far behind.

Market optimists feel that the economy can co-exist with the virus. Despite the rising cases in the U.S., a complete lockdown is not expected to occur again. There will be more of a regional approach in the U.S. to combat virus hotspots in the U.S. We can also expect more reliance on their population to adhere to mask-wearing and social distancing. Optimists also believe that tremendous progress is being made toward vaccine development, and are confident that there will be a vaccine by the end of 2020 or in early 2021.

Many believe that the majority of the job losses incurred in the pandemic are not permanent. They anticipate that travel and vacations will gradually resume in late 2020 and early 2021, and when and if a vaccine is in place, the resurgence in travel will be significantly accelerated.

So there you have it. Clearly, there are significantly opposing views on where markets will go from here. Whichever side you’re leaning towards, remember that it takes neither savant nor soothsayer to know that trying to time the markets is risky at best, and usually leads to poor decisions and even poorer results. When times are at their worst (as I spoke about on March 23), those who understand the value of sticking to a long-term investment plan and stay invested will ultimately benefit in the long run.

 

Steven Belchetz, SVP Business Development & Client Relationships

CWB Private Investment Counsel

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These articles are for general informational purposes only. Please obtain professional advice before taking any action based on this information. No endorsement or approval of any third parties or their advice, information, products or services should be implied by any references to third parties contained in any article. Trademarks cited in these articles are the respective properties of their owners.

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