If you didn’t pay much attention to investment forecasts at the start of the year, good for you. With the economy humming and the stock market climbing ever higher, such prognostications didn’t seem all that important back then. Besides, they turned out drastically wrong.
The coronavirus outbreak, economy-closing orders to contain it and unprecedented government stimulus efforts to reverse the financial fallout changed the outlook dramatically.
“If ever there was a year that needed a mid-year review, it is this,” quipped David Kelly, chief global strategist at J.P. Morgan Asset Management, in a recent webinar.
With so much in flux, it won’t be easy for investors to set a solid course over the next six months, but here are some of the trends and themes that might prove critical:
Hoping for the virus to ebb
The pandemic has shifted the economy’s trajectory from one of long-term expansion to severe recession. But now that the number of new virus cases in the U.S. has slowed and the economy gradually is reopening, more people are sensing normalcy ahead and investors are growing more buoyant.
Despite a recent rough patch, the broad Wilshire 5000 index as of June 11 was still up nearly 36% since hitting recent lows on March 23, with the stock market thus exhibiting much more resiliency than the economy.
We won’t be out of the woods until a vaccine has been developed and broadly distributed. New virus outbreaks remain a stark threat, especially as social distancing precautions are relaxed. Kelly describes the current climate as a “bookend recession” marked by the arrival of the virus at one end and a vaccine at the other.
Dealing with recession
The economy went from boom to bust in a matter of weeks, with millions of people thrown out of work, hundreds of thousands of businesses shut or disrupted, corporate profits slumping and the second-quarter gross domestic product possibly looking at an annualized decline of around 40%.
The economy has stabilized a bit and the next direction could point upward. But it’s uncertain whether the recovery will be rapid or prolonged. The jobless numbers still look bleak and could remain so for a lot longer. The lack of improvement in unemployment-insurance claims suggests the job market hasn’t healed much, said Nationwide economist Scott Murray.
Until very recently, stock-market investors mostly were looking past the chasm, sensing better business conditions six or nine months hence.
“Investors, by their very nature, tend to be optimists,” said Jay Penney, chief investment strategist at Ashton Thomas Private Wealth in Scottsdale. “The very act of deploying one’s hard-earned capital into businesses is an act of faith.”
Ignoring profits for a while
Investors will need some faith when it comes to profitability. Corporate earnings weren’t all that great in the first quarter and they will be dismal in the second. The question ahead is whether profits recover substantially by 2021, or whether it takes longer.
The worst of the earnings reports likely will come in the current quarter, but bad news could persist well into the second half of 2020, wrote Sheraz Mian, research director at Zacks Investment Research.
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His current expectation, based on Wall Street forecasts, is for a 24% drop in overall profits for companies in the Standard & Poor’s 500 index this year, followed by a rise of nearly 27% in 2021.
Plunging profits will worsen price/earnings ratios and other stock-valuation measures, so investors might need to ignore them for a while or risk becoming overly conservative.
Counting down to the election
With all that has happened lately, it’s easy to forget that a presidential election is just four-plus months away. Normally, this is the time when campaigns swing into high gear, highlighted by candidates speaking to enthusiastic audiences in large arenas. Social distancing will limit that, so much of the hoopla has fizzled away.
Normally, incumbents stand a good chance of winning re-election, especially when the economy is faring well. But President Trump’s outlook has dimmed with the virus outbreak and economic slump.
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A quick rebound would help Trump. But of the 10 states with the tightest presidential votes in 2016, nine currently have double-digit unemployment rates, a bad sign for the president, noted J.P. Morgan. The list includes Arizona, Michigan, Pennsylvania, Wisconsin, Florida, Nevada and North Carolina.
Presidential election years typically are good for the stock market, with the S&P 500 advancing in 17 of the past 20 presidential-election years. But there have been exceptions, such as the 37% plunge in 2008, during the last recession.
Getting a lift from low yields
Most of the stock market’s rally can be attributed to progress in combating the virus and stabilizing the economy. The bond market also has helped: As yields have dropped with the ebbing in interest rates, bonds and bond funds look much less appealing now when compared to stocks.
Bonds still have a place in investor portfolios, as they provide relative price stability with some income. But bond investments, at today’s yields, aren’t going to make anyone rich.
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And while not as volatile as stocks, bonds come with their own risks. One is the rising chance of default on bonds issued by corporations and some municipalities. One in nine “investment grade” or higher-quality bonds already has been downgraded this year, with more negative evaluations coming, according to J.P. Morgan.
Spiking interest rates could present an even greater threat to bonds overall, as that would push prices lower across the board. But that doesn’t seem to be a problem for now, as the Federal Reserve has signaled it won’t raise rates at least until 2022.
Awaiting further government stimulus
Washington’s ability to prop up the economy with stimulus checks, enhanced jobless benefits, forgivable small-business loans and more has helped to keep consumers spending and companies afloat while encouraging investors to stomach more risk.
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Despite $2.4 trillion already spent in coronavirus relief, worsening an already-bad federal debt situation, more help might be necessary. Kelly thinks lawmakers will need to ante up billions of dollars more to keep state and local governments afloat at a time when tax revenue has ebbed. He also hopes to see federal jobless benefits extended, at least for low-income workers, after the special $600 a week program expires at the end of July.
Perhaps $600 a week is too much jobless aid but zero would be too little, Kelly contends. “There will be real poverty … if we don’t help workers beyond July,” he said.
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