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Weekly Market Update (October 12, 2020 - October 16, 2020)

By: Angelo Kourkafas, CFA® October 16, 2020

Equity markets finished slightly higher last week as investors continue to hope for a fiscal stimulus package. On the vaccine front, some trials have been paused due to health concerns, and Pfizer has filed an emergency-use plan for the end of November. Retail sales continue to be a bright spot for the economy, showing unexpected gains in September, even while jobless claims came in higher than expected and job growth showed signs of slowing.

Our Quarterly Market Outlook

Stocks oscillated between positive and negative territory last week, reflecting a tug-of-war between rising concerns and encouraging economic data. Weakness last week stemmed from a continued stalemate in stimulus talks, along with the recent rise in COVID-19 cases and the accompanying worries over implications for the continued reopening of the economy. Markets did find a lift from a positive U.S. retail sales report that showed consumer spending rose strongly in September despite the lack of renewed aid from Washington, signaling some resiliency to the recovery. We believe that the broader fundamental outlook remains intact, but as last week demonstrated, policy support and the path of the virus, along with the discovery of an effective vaccine, will be key drivers in the months ahead. Here are our thoughts on the progressing investment outlook:

Economic outlook: Recovery entering a slower phase
We believe the economy has likely formed a durable bottom, but the pace of growth will slow, and the return to pre-pandemic levels will take time. Despite uncertainties, a gradual improvement in the labor market, along with low interest rates and fiscal stimulus, should help sustain the economic recovery into 2021.

  • Following a record GDP decline in the second quarter, the economy experienced an initial V-shaped recovery and has recovered almost two-thirds of its pandemic-induced losses. As fiscal relief is gradually phased out and the initial reopening boost fades, we believe this strong rebound will give way to slower but sustained growth.
  • Unemployment remains high, and further employment gains are needed to support the handoff from stimulus to growth and help drive consumer spending, which makes up the lion’s share of the economy. But consumers are in better shape compared with past recessions, with the personal-saving rate elevated and debt ratios low.
  • The pandemic has created a two-track economy as major industries either remain capacity constrained or experience weak demand. For example, as of August, consumer spending in goods was 5% above the February peak, but spending on the far bigger category of services (e.g., restaurants, hotels) remained 7% below peak1. This uneven recovery is preventing the economy from reaching its full potential, and it is likely to persist until a vaccine arrives.

Equity outlook: A new bull emerges, but stocks may take a breather
The longer-term outlook for stocks is positive, in our view, with support from economic growth, corporate earnings and interest rates. In the near term, we expect volatility to remain elevated and markets to consolidate recent gains. We don’t believe the gains experienced since March will be matched in the months ahead, but we do think a durable economic expansion will give legs to the new bull market.

  • Corporate earnings have taken a sizable hit, declining 35% in the second quarter1. Earnings are expected to improve in the latter part of 2020 and then rebound strongly in 2021. This severe recession was short-lived, which helped corporate profitability hold up better than expected. In addition, earnings for the two most heavily weighted sectors – technology and health care – remained resilient. As the economic recovery plays out, we expect the equity rally to broaden, potentially driving a rebound in asset classes and sectors that have lagged.
  • The quarter ahead looks increasingly challenging amid virus concerns, waning fiscal support, and rising U.S./China tensions. At the same time, full valuations leave little margin for error and are likely to drive more moderate gains. We think the new bull market has legs, but we expect periodic setbacks to produce episodes of volatility.

Fixed-income outlook: Interest rates to stay low for longer
Through near-zero interest rates, bond purchases, and newly enacted credit facilities, the Federal Reserve has gone to extraordinary measures to provide ample liquidity to the credit market. We expect monetary policy will remain highly accommodative for several years to support the economic recovery.

  • The Fed is likely to keep the benchmark federal funds rate, which provides an anchor for short-term rates, near zero through 2023. Additionally, the central bank has committed to continued purchases of bonds (Treasuries, corporates and mortgage securities) to keep borrowing costs low for consumers and firms.
  • In September, the Fed announced it would no longer pre-emptively raise interest rates as inflation crept above its 2% target. Instead, higher levels of inflation would be tolerated “for some time” before the Fed hiked interest rates. This new policy framework gives the Fed flexibility to keep rates low to stimulate the economy and, by doing so, help drive down the unemployment rate closer to pre-pandemic levels.
  • Even at low rates, bonds tend to move in the opposite direction of equities. Moreover, real yields (nominal rates adjusted for inflation) are below zero. Cash and other short-term debt instruments are unlikely to hold their value in the current macroeconomic environment. Owning bonds across a range of maturities gives you the opportunity to reinvest maturing securities at higher yields as the economy recovers.

International outlook: Global rebound aided by policy support
The global economy is in the early stages of a rebound, though disparate conditions between major economic regions and resurfacing pandemic challenges will likely make for a protracted recovery. We think monetary and fiscal policies will remain highly supportive. An enduring, though modest, expansion should support positive global equity-market performance ahead.

  • The international rebound is underway but won’t proceed in a rapid or steady fashion. Despite reopening setbacks, threats to global trade activity, and political instability, we think global growth will improve next year, aided significantly by continued sizable monetary and fiscal stimulus abroad. Coordination by EU policymakers to launch the euro recovery fund, aggressive stimulus from the world’s major central banks, and accommodative policies from Chinese authorities signal to us that global policymakers are committed to fostering a sustained recovery.
  • The U.S. dollar appreciated steadily in recent years, but the pandemic-driven global recession has reshuffled the deck. We think the strength of the U.S. dollar could abate. Improving global growth can be a headwind for the greenback because the dollar is more of a safe-haven currency. Smaller interest-rate differentials between the U.S. and foreign markets offer less upward support for the dollar.
  • As the global expansion gains footing, we think investment performance will broaden beyond the leadership so far in this rally. We think this warrants exposure to lagging areas such as global equities and cyclical assets/sectors, which have higher representation in foreign equity markets.

Detailed Quarterly Market Outlook

Angelo Kourkafas, CFA
Nela Richardson, PhD
Craig Fehr, CFA

Source: 1. FactSet

Index Close Week YTD
Dow Jones Industrial Average 28,606 0.1% 0.2%
S&P 500 Index 3,484 0.2% 7.8%
NASDAQ 11,672

0.8%

30.1%

MSCI EAFE 1,882.36 -1.5% -7.6%
10-yr Treasury Yield 0.74% 0.0% -1.2%
Oil ($/bbl) $41.00 1.0% -32.9%

Bonds

$117.89 0.1% 6.8%

Source: Factset, 10/16/2020. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.

The Week Ahead

Important economic news coming out this week include housing data and the preliminary October Purchasing Managers' Index.

Important Information

The Weekly Market Update is published every Friday, after market close.

Market indexes are unmanaged and cannot be invested into directly and are not meant to depict an actual investment.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against loss.

Systematic investing does not guarantee a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.

Dividends may be increased, decreased or eliminated at any time without notice.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

The content of this report is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.

All content of the Dow Jones Indexes © 2017 is proprietary to Dow Jones & Company, Inc.

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