S&P 500 positive for the year despite ongoing challenges
JUL. 20, 2020
Equity markets rose for the third-straight week and the seventh time in nine weeks, as equity markets continue to diverge from the news flow on the outbreak. The disconnect is evident not only in the direction of the move, but also in the lack of volatility. The S&P 500 IndexTM has a positive total return of 1% this year despite an estimated decline in GDP of 5% and earnings of 22%. Equity markets tend to lead economic recoveries, but also tend to see exaggerated swings based on emotion.
We are seeing early signs of a shift in market leadership, with a sharp decline in momentum and growth offset by strength in value and cyclicals. Value and international are substantially underweight in many investor portfolios, and a shift in leadership could be sustained. Names that had led over the past year were notable underperformers last week. We are beginning to see leadership in healthcare on vaccine hopes and industrials and materials on the weaker dollar. We begin the week at an interesting technical level for the S&P 500, as we approach the high from early June. If that is breached, the next resistance level is the previous high from February. A shift in leadership would be notable considering the outperformance of growth versus value is at a historic high, but a broadening leadership could make the rally more sustainable.
Earnings season began last week, with investors showing willingness to look beyond the current weakness and focusing on the future. The second quarter is expected to see a 44% decline in earnings on a 11% drop in revenues. Last week, we saw companies beating estimates rewarded more than average, while those who missed were punished less than average, suggesting a glass-half-full posture. Based on the depressed earnings, the S&P 500 currently trades at 22x forward earnings, roughly 50% higher than the average from the past decade, suggesting that the margin for error is eroding.
Economists are bracing for the next round of layoffs, as the hopes for a quick economic recovery fade. Leaders in industries ranging from restaurants to media have been forced to reimagine their business models for the new reality. In the most recent jobs report, there was a notable shift from temporary to permanent unemployment. Additionally, while job losses have been the primary focus, a study from the University of Chicago noted that 4 million workers have received pay cuts since February through lower wages of reduced hours. The prospect for a quick resumption of previous wages is fading as much of the economy remains shuttered and the outbreak continues to impact consumer behavior.
Congress is expected to reach a deal on a fifth coronavirus relief package, though significant differences remain between Democrats and Republicans. The $1 trillion targeted by Republicans is a fraction of the $3+ trillion already passed by House Democrats. A primary disagreement is around enhanced unemployment benefits, where the Democrats want to extend the $600 per week of additional benefits, while the Republicans fear that it discourages the return to work and would like to reduce or eliminate it. Additionally, Democrats want an additional $1,200 check to individuals, while Republicans want to limit it to the lower end if the income distribution. Joe Biden continues to extend his lead over President Trump in many polls, with betting markets pricing in a Democrat sweep in November.
The dollar index is nearing an 18-month low versus a basket of trading peers and a two-year low versus the euro, as the U.S. recovery from the coronavirus outbreak has been frustrating. The dollar index has lost 7% since mid-March, perhaps complicating the recovery. The strong dollar was an indication of the U.S.’s stature in the world as a safe-haven, though recent data show shift. A persistently weaker dollar would put upward pressure on interest rates and inflation, which would complicate the path for fiscal and monetary stimulus.
What to Watch
Earnings season continues to expand this week, with close attention being paid to the forward outlook. Economic data is relatively light, led by existing home sales on Wednesday, leading indicators Thursday and PMI data and new home sales on Friday.
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