We are more optimistic. Why you should be, too.

The Fed’s change is a positive for economic growth, and a post-lockdown recovery seems well underway.


Our Top Market Takeaways for September 4, 2020.

Market update

Song of the summer 1

Summer of 2020 will be remembered for the COVID-19 pandemic, protests against racial injustice, debates over returning to school or the office, and political posturing before what is set to be a contentious presidential election.

It will also be remembered for the confounding behavior of financial markets. They rallied, even though the world and the economy still feel chaotic and broken. Some examples:

  • There are still around 40,000 new coronavirus cases per day in the United States.
  • Over 10 million Americans are still out of work due to the pandemic and the economic fallout.
  • Economy-wide corporate profits have plummeted by 20%.
  • More than half of small businesses report being worried about permanent closures.
  • Large company bankruptcies are at their highest levels since the Global Financial Crisis.

The economy may still seem broken, but it has gotten better. Especially in the ways that financial markets care about.

  • Coronavirus cases in the United States have been declining since June, and there are nine vaccine candidates in Stage 3 trials.
  • The economy, while still operating below pre-pandemic levels, has staged a robust and rapid recovery after lockdowns were lifted and in spite of a resurgence in new cases across the South and West.
  • Corporate earnings expectations are now rising.
  • The Federal Reserve has reconfigured the way it will conduct monetary policy. We covered this in detail last week, but the upshot is that it’ll be more supportive of growth as the central bank works to achieve an average inflation rate of 2% over time.           

A new economic cycle also started this summer. If the Fed gets its way, it’ll be a long one, marked by falling unemployment, rising wages and higher corporate profits. Markets, for their part, started to price in that possibility, and delivered excellent returns to investors across most asset classes (to be sure, it came with moments of volatility, yesterday’s ~5% fall in the NASDAQ and ~3.5% fall in the S&P 500 included). The question is, as always, where do we go from here?

A more optimistic view


We’re growing more optimistic about the future, particularly in the medium term.

The Fed’s change is a positive for economic growth. It seems likely that the days of rate hikes to preemptively stifle inflation are over. In the near term, the post-lockdown recovery still looks robust, and consensus expectations for economic growth still seem too pessimistic. Consumer spending on houses, home improvement and electronics are all impressive and unexpected, and companies will need to rebuild their inventories. The economy probably still needs another round of fiscal support, and there are still questions about the virus, but the post-lockdown recovery seems well underway.  

What does all this mean for investors?

Inflation is still a long way from getting to a sustained level where the Fed would raise rates to put the brakes on growth. Because cash rates and U.S. Treasury yields reflect expectations about future Fed policy moves, interest rates are probably not going to move materially higher anytime soon. Cash should therefore be viewed very critically. Be thoughtful about how much you’re holding, and the opportunity cost of doing so. Supportive Fed policy also bodes well for corporate credit, where there is still some yield to be had. We like the upper-tier portion of high yield (ex-energy) the best, and given spreads are still above their pre-crisis levels, we think it could generate returns in the mid-to-high single digits over the next 12 months.

As for stocks, we think you should believe the rally, and we expect more gains over the next few years. It seems clear that what was once thought of as a fleeting bear market rally is strength that’s here to stay. In large part, this is a legitimate reflection of the value of secular growth: The tech sector was able to grow earnings through the pandemic. It may not seem compelling to invest in U.S. equities now when they are at all-time highs, when valuations seem stretched, and when there are still many uncertainties on the horizon. However...

The macroeconomic, monetary and business cycle environments all seem supportive for equities over the next 3–5 years. We’re in the midst of a strong early-cycle recovery (new home sales are growing at their fastest pace since the early 1990s), and the Fed has signaled it is going to keep interest rates low for a long time. This is supportive both for future earnings expectations and equity valuations. It may not feel like you are getting a bargain, but we think equities can still provide compelling returns over the next several years. In particular, lower rates support our view that secular growers will command a premium from investors and should not be ignored, even after an eye-popping rally. The reason: Cash flows that happen far in the future are very valuable when discount rates are low.

We also believe the U.S. dollar should continue to weaken. With this, equity markets outside the United States are starting to look more compelling. We also believe the macroeconomic and policy backdrop could help gold and some industrial commodities.

What are the risks?

There are also risks: The most important of which would be if the Fed abandoned its responsibility for financial stability and allowed an asset price bubble. A strong underlying economy, combined with stimulative monetary (and fiscal) policy, could lead to exuberance and overextension. However, if this does happen, it would likely to play out over a number of years, rather than quarters or months. Downside risks include a chaotic presidential election in the United States, continued trade tensions between the United States and China, and a still unresolved global pandemic.

There are always risks, but the bottom line is that the post-COVID-19 recovery is well underway. As we continue to progress through the recovery and into expansion, the Federal Reserve has committed to supporting the economy for longer than it has historically. For an economy that’s exiting recession, this should make long-term investors optimistic about the future. There’s always noise (the election in November is the loudest), but the overall environment seems supportive for risk assets over the next few years.

Happy Labor Day

If you have been reading us all summer, you may be familiar with our “Memorial Day” and “Fourth of July” stock basket. Composed of boat makers, home improvement stores and cooler brands, among others, it has showed stellar performance relative to broad markets. Enjoy the long weekend.

1. Some of the actual songs of the summer: “the 1” (Taylor Swift), “Pelota” (Khruangbin), “Rain on Me” (Lady Gaga w/Ariana Grande), “Live Well” (Palace).

All market and economic data as of September 2020 and sourced from Bloomberg and FactSet unless otherwise stated.

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