In the months since the first outbreak of the corona virus, the economy and markets were on the verge of collapse to recover quickly. I recently sat down with my colleague and investment strategist Talley Leger to discuss the sustainability of this recent recovery.
Brian: I will start with a compliment if you promise not to let it go in your head. Your market bottom framework proved to be predictive in late March as extreme volatility, catastrophic investor sentiment, one-sided investor positioning and a catastrophic market breadth led you to believe that the market was bottoming out. Fast forward 17 weeks and the US stock market has almost completely recovered. First, what has driven market retracement and what can an investor do now?
Talley: You’re too nice – and give me too much appreciation. It is one thing to provide investors with a framework and indicators to help them get the stock priming process under control. It’s another thing to correctly name the form of recovery. I admit to be surprised by the V-shaped recovery in stocks and the fact that the market hasn’t retested the March low.
As far as I can tell, there are at least 9 tailwinds behind the stocks:
- Massive, unprecedented and coordinated monetary policy support;
- Similarly impressive fiscal support;
- Still cautious investor positioning in the form of high cash balances and net short positions in stocks;
- Negative investor sentiment expressed by continued outflows of stocks and more bears than bulls in the retail investor survey;
- Structurally oversold terms in rolling 20-year total returns on stocks;
- Possible treatments for the disease caused by the coronavirus, which is researched and developed by a variety of companies around the world, some of which have gone into human studies;
- Potential vaccines against the coronavirus itself that are developing at a similar rate;
- The high-frequency economic data, such as weekly initial applications for unemployment insurance, have improved; and
- The economy is reopening and activities are moving in the right direction, as evidenced by daily mobility data.1
That said, there is also a bearish argument for the market, namely:
- Fears of a potentially fatal second wave of the corona virus as the economy reopens and the cooler autumn weather approaches;
- The risk of a negative feedback loop between inventories and gross domestic production (GDP) in the second quarter of 2020 and earnings per share (EPS);
- Increased tensions between the US and China;
- Overvaluation; and
- Tactically overbought terms.
All valid points, each of which could be the trigger for a short-term share withdrawal.
Still, I’m still constrained by the comparable breadth and scope of the bullish case, which leads me to believe that short-term turbulence should be seen as a long-term buy and hold option by investors.
Brian: I am also forced by the comparative breadth and scope of the bullish case. I don’t think the saying is now against the Fed and any other central bank in the world, nor against the European Commission and the US Congress. There has already been a new surge in cases regarding your bear case, and as the US economy slows it doesn’t seem to collapse like it did during the Great Shutdown. Mobility may have reached a plateau (I haven’t visited too many places in the past few months), but it doesn’t seem to be collapsing. I suspect that for the time being and until a medical breakthrough, we will take reasonable precautions – masks, outdoor gatherings, social distance – to avoid the draconian deadlocks and catastrophic economic collapse earlier this year. Overall, valuations have increased, but the discount rate continues to fall. I guess we have to make ourselves comfortable paying higher multipliers for stocks in a world with almost zero interest rates.
Regardless of whether there is a short-term retreat, we both believe that weak, lengthy recoveries with overly accommodative policies are good for stocks in the long run. How do you position yourself for a lengthy recovery?
Talley: From the perspective of the industry and the industry, there have been signs of a cyclical return to the market after the past few weeks (read: summer doldrums).2nd Within technology, semiconductors achieve new highs compared to software. In other countries, both the industrial and materials sectors are consolidating. The lumber continues to rise and the builders are still behaving well. We also saw copper and other metals (e.g. zinc, tin, nickel, aluminum and silver) recover.
While it is risky to make pure, directional calls in the cyclical or defensive sectors of the market, my long-term optimism is forcing me to be optimistic about the US stock market and the economic recovery. Like-minded investors should think twice before securing the advance.
Not to be obsessed with a short-term retreat, but are you concerned with the concentration of the market on a handful of technology companies? While the S&P 500 index can be positive for 2020, can that be said for most S&P 500 stocks?
Brian: The biggest challenge when trying to time the market or adequately hedge your portfolio is knowing when to risk again. Would I be surprised if some of the market’s high-flying drivers lag behind the more economically sensitive segments or even return some of the recent gains? History suggests that corrections are common.
But here too it is a time problem. Equity investors have to ask themselves what types of companies they want to own in the long term. For me, it depends on which companies are the disruptors and which companies are disrupted. The soaring winners in this market disrupt the way business, economy and society work. We may pay a higher share multiplier for these companies than for the broader market, but we would also expect their earnings to grow faster than for the broader market.
I give you the last word. How do you see the dollar’s recent weakness? Is this the catalyst to unlock the deep value of international markets?
Talley: The Federal Reserve (Fed) has entered into an apparently perpetual commitment to buy securities until the economic and labor market outlook has improved significantly.
An important consequence of the Fed’s unprecedented expansion in its balance sheet is the weakness of the US dollar, which should intensify the flourishing rally in international markets, particularly in emerging markets (EM) and Chinese stocks.
If quantitative easing (QE) is a choice between interest rates and the US dollar, the Fed has decided to save growth and jobs by loosening the money screws and inflating the money supply at the expense of the currency. From this perspective, it can be expected that the US dollar will weaken further if the Fed keeps such an abundant currency supply in circulation.
In their view, the structural underperformance of Chinese and EM stocks – until recently – has reduced the price-performance ratio to low discounts compared to the world index and history.
While valuation is a good starting point for an investment thesis, it is not enough on its own. Attractive valuations combined with a weaker US dollar and improved economic growth abroad could be a powerful way to unlock the potential rewards of EM stocks, and so far it seems to be working.
Footnotes:
- Source: Our world in data. https://ourworldindata.org/covid-mobility-trends
- The summer lull is a perceived seasonal trend where the market declines or stagnates during the summer months
Important information
Blog header image: Robert Anasch / Unsplash
Every investment involves a risk, including a risk of loss.
The risk of investing in securities of foreign issuers, including emerging market issuers, may include fluctuations in the foreign currency, political and economic instability, and foreign tax issues.
The big shutdown is the period between March and the present day when the country was enforced
Quantitative easing is a form of unconventional monetary policy in which central banks buy long-term securities to increase the money supply and promote lending
The price-performance ratio is calculated by dividing a company’s share price by sales.
The S&P 500 Index is a stock market index that measures the stock performance of 500 large companies listed on US stock exchanges.
The opinions above are those of the authors on July 27, 2020. These comments should not be interpreted as recommendations, but rather as an illustration of more general topics. Forward-looking statements are not guarantees of future results. They contain risks, uncertainties and assumptions; There can be no guarantee that actual results will not differ materially from expectations.
Talley Léger is an investment strategist for the Global Thought Leadership team. In this role, he is responsible for the formulation and communication of macro and investment knowledge with a focus on stocks. Mr. Léger deals with macro research, cross-market strategy and equity strategy.
Mr. Léger came to Invesco when the company merged with OppenheimerFunds in 2019. At OppenheimerFunds he was a stock strategist. Before joining Oppenheimer Funds, he was the founder of Macro Vision Research and held strategic positions at Barclays Capital, ISI, Merrill Lynch, RBC Capital Markets and Brown Brothers Harriman. Mr. Léger has been in the industry since 2001.
He is the co-author of the revised second edition of From Bear to Bull with ETFs. Mr. Léger was a guest columnist for The Big Picture and for “Data Watch” at Bloomberg Brief and author at Seeking Alpha (seekalpha.com). He has been cited in The Associated Press, Barrons, Bloomberg, Business Week, Dow Jones Newswires, The Financial Times, MarketWatch, Morningstar Magazine, The New York Times and The Wall Street Journal. Mr. Léger is on Bloomberg TV, BNN Bloomberg, CNBC, Reuters TV, The Street and Yahoo! Finance and spoke on Bloomberg radio.
Mr. Léger earned an MS degree in Financial Economics and a Bachelor of Music from Boston University. He is a member of the Global Interdependence Center (GIC) and has Series 7 registration.
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