The Fed shifts on inflation – What does it mean?
The Fed unveiled a revision to its monetary policy, allowing for higher inflation to help support the labor market. We believe this action could keep interest rates low for years.
Market overview. With third quarter earnings season upon us, we see a continuation of the V-shaped recovery in terms of risk taking as the underlying macro backdrop continues to improve. While the market may experience volatility around next month’s election, we continue to focus on longer-term fundamentals as uncertainty begins to subside.
Market consensus expects S&P 500 Index earnings to drop more than 20% from $165 in 2019, to $130 in 2020. So why are the markets at all-time highs? We believe it is because the market has mapped out a trajectory of earnings to a full recovery, with consensus expecting earnings to be back at $165 in 2021.
However, within the broad market, there are certainly stories of haves and have nots. Sectors like health care, consumer staples and information technology are experiencing positive sales and earnings growth, while sectors like energy have seen dramatic declines in sales and earnings. According to Goldman Sachs, 35 companies listed on the S&P 500 Index are expected to post double-digit sales growth and margin expansion of 50 basis points or greater for the third quarter. These stocks – from six sectors – have posted a median year-to-date return of 31%. This exemplifies our belief there are pockets of opportunity in the market, but active investors need to pick their spots carefully.
Beyond results this earnings season, we are keenly focused on the underlying issues of business models, management teams and companies’ commitment to deliver for customers and shareholders. We believe leadership and integrity are investable realities and the bigger picture is more important than ever in these uncertain times. Likewise, we believe companies with strong underlying fundamentals are reflected in the leadership in the market.
Global economy rebounds. Third quarter economic data show the global economy has had a very strong bounce. Going forward, we believe a natural deceleration in growth is very likely given the magnitude of the bounce back for the period. In addition, we believe we could see more deceleration than consensus in the final three months of the year. Our belief is driven by the impending arrival of cold weather, which will dampen outdoor consumer activity and negatively impact certain industries. One area that is likely to take a hit is restaurants, some of which may have benefitted from moving operations outside during the warmer months.
With respect to the U.S. consumer, we anticipate a pullback in consumption due to a lack of opportunities to spend. We see evidence of this in the extremely high savings rate in the U.S. now. Spending data through August show that spending on durable goods is well above pre-virus levels, while spending on services is still far below pre-pandemic levels. Services like travel, recreation and dining are among the areas hardest hit. We think this limitation on spending opportunities is going to be a cap on consumption over the next few months.
Pandemic impacts persist. Cases of COVID-19 are rising in the U.S. Hospitalizations also are increasing but are contained in comparison to the initial spike in March and April. In Europe, case counts are rising as well. We are beginning to see targeted quarantine measures in some countries, but governments thus far have avoided reverting to the broad lockdowns that so damaged economic growth earlier this year. However, the COVID-19 spike is negatively impacting European growth, which we believe is likely to continue due to the rising case counts and increased containment measures in some areas.
In China, retail sales data from the recent Golden Week holiday showed consumption jumping nearly 5% versus last year. Manufacturing data and infrastructure spending continue to be healthy, while the travel sector remains depressed.
Election Day approaches. Looking at the 2020 elections, Democratic presidential nominee Joe Biden continues to widen his lead over President Donald Trump in national polls. We are closely watching polls in the swing states like Florida, Pennsylvania and Wisconsin where Biden’s lead also is growing. In the race for control of the U.S. Senate, recent polls show Democrats are leading in some races for seats currently held by Republicans. If Biden were to win, the Democrats only need a net gain of three seats to control the Senate. Our base case is the Democrats would have a narrow majority of 50 or 51 seats with the vice president available to vote to break a 50-50 tie on any legislation. If Biden wins by a large margin and the Democratic “blue wave” turns into a “blue tsunami”, Democrats may end up with majority of 54 or 55 seats, which would allow them to pass a broader agenda.
We still believe odds are low for any substantial stimulus being approved before the election. However, we believe it could likely pass in early 2021. If the Democrats sweep the White House and Congress, we would expect a sizeable stimulus act. We believe the desire for a big stimulus package is a big factor why the markets are rallying as the odds of a Democratic sweep increaseon the prospect of a blue tsunami, despite more medium-term potential negative impacts from higher taxes and regulation.
Past performance is no guarantee of future results. This information is not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through Oct. 12, 2020, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This information is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.
Risk Factors: Investing involves risk and the potential to lose principal. Fixed-income securities are subject to interest rate risk and, as such, the value of such securities may fall as interest rates rise. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
The S&P 500® Index is a float-adjusted market capitalization weighted index that measures the large-capitalization of the U.S. equity market. It is not possible to invest directly in an index.
The impact of COVID-19, and other infectious illness outbreaks that may arise in the future, could adversely affect the economies of many nations or the entire global economy, individual issuers and capital markets in ways that cannot necessarily be foreseen. In addition, the impact of infectious illnesses in emerging market countries may be greater due to generally less established healthcare systems. Public health crises caused by the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries or globally. The duration of the COVID-19 outbreak and its effects cannot be determined with certainty.