“We really can’t forecast all that well, and yet we pretend that we can, but we really can’t.”
–Alan Greenspan, Former Chair of the Federal Reserve of the United States
“Weather forecast for tonight: dark.”
–George Carlin, American comedian
Imagine yourself at the beginning of the year. You have knowledge that within weeks a novel virus will emerge that will shut down much of the global economy. Businesses will close, sporting events will be canceled, your daily routine will be altered, travel plans will be derailed, and tens of millions of Americans will be thrown out of work. There is no preventative vaccine, no cure, and the virus can be contracted like the common cold or the flu via airborne contact.
With the perfect foreknowledge that a global pandemic and economic collapse is on the horizon, how might you position your investment portfolio? Of course, you would have correctly anticipated a swift sell-off in stocks as the virus swept across the globe and the U.S. economy went into hibernation. The safety of cash or long-term Treasury bonds would have been alluring.
At the bottom in March, that was the end of your perfect foreknowledge, so might you decide to repurchase equities, returning to the proper asset allocation designed to achieve you financial goals? Would the unending drumbeat of bearish sentiment have kept you out of the market and in the safety of cash or government bonds? For many, it’s difficult to pull the trigger when the news is bleak, and there’s no light at the end of a dark tunnel.
The sell-off in stocks was swift, violent, and short-lived.
As the economy was on the precipice of its worst quarterly decline on record, the major market indexes touched bottom in late March and began a remarkable rally that few thought possible. In fact, the Dow Jones Industrial Average registered its best 100-day advance since 1933 (March 23 bottom—100 trading days). While the Dow Jones Industrial has yet to eclipse its prior high, the S&P 500 Index set a new record on August 18 and proceeded to set six new closing highs by the end of August.
The pandemic changed the rules. There’s no playbook to model outcomes. The Fed, economists and analysts are all playing by new rules.
Aided by fiscal and monetary stimulus, price action in the market since late March accurately called the bounce in economic activity that began in May and has continued into August. We’re seeing a strong stock market, which has been supported by unprecedented liquidity supplied by the Fed, rock bottom interest rates, and an improvement in the overall economy. Buoyed by low mortgage rates and pent-up demand, housing activity, a traditional leading economic indicator, has surged.
Meanwhile, the economy may need another shot of fiscal stimulus, but lawmakers are at an impasse.
A liquidity crisis was avoided when the Fed flooded the financial system with cash, but economic output remains subpar, and potential solvency issues among homeowners and businesses may create new hurdles down the road.
Final thoughts
We remain incredibly bullish on the long-term prospects for the U.S. economy, but we are monitoring short-term risks. Outsized gains in a few technology shares leave the market vulnerable to a pullback. When we see stocks priced at lofty levels, any unexpected surprises can create volatility.
The path of the virus remains top of mind. Fortunately, the mid-summer spike in cases has subsided. Yet, could we see a second wave in the fall or winter? Might we see a resurgence in the virus amid the Labor Day holiday and reopening of schools? What if the massive effort to develop a vaccine comes up short?
The election is barely two months away, which could create headline risk. Or, might tensions between the U.S. and China generate waves in the market? While markets don’t always get it right, they attempt to price in the future. Markets are made up of millions of investors that have a financial stake in their decisions. Current price action suggests the economy will continue to improve, though the pace of improvement is uncertain.