Market views from BlackRock Active Equities

Taking stock: Q3 equity market outlook

Tony DeSpirito |Jun 26, 2020

When weeks feel like years. The first half of 2020 brought more market activity and angst than many full years or even decades. As we look toward recovery from the coronavirus shock, we see:

  • Equal reasons for caution and optimism on U.S. stocks.
  • Hopeful signs for the U.S. economy based on lessons from China.
  • Attractive opportunity for income in equities, even amid dividend cuts.

Market overview and outlook

The mood, and the market, has evolved at a furious pace since our last quarterly commentary. Morningstar data is telling: The S&P 500 Index notched +/-4% moves in 17 trading days through mid-June of this year versus an annual average of just 3.2 days from 1928-2019. The economic and market metrics are now trending in the right direction. The question is whether the market has moved too far, too fast and priced in all or most of the good news. The chart below shows the change in the S&P 500 versus jobless claims, a key economic indicator. We see equal reasons for caution and optimism as we enter the second half of 2020.

The market is looking ahead
S&P 500 Index performance and U.S. jobless claims, 2020

The market is looking ahead

 

Source: BlackRock Investment Institute, with data from Refinitiv Datastream, June 2020. Jobless claims are weekly from Jan. 31-June 5, 2020. S&P 500 level rebased to 100 as of Jan. 31, 2020. Index performance shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not a reliable indicator of current or future results.

While we are unlikely to retest the March lows, the market has moved very far, very fast. It is prudent to prepare for further volatility.

Reasons for optimism

  1. Solid economic foundation
    The U.S. economy was healthy leading into the COVID-19 crisis. The ensuing recession was caused by an exogenous shock, not a typical end to the business cycle driven by economic overheating. This could hold promise for the recovery.
  2. Credible, coordinated policy response
    The global coordination, swiftness and magnitude of the monetary and fiscal policy response is unprecedented and should provide the support needed to bridge the gap toward economic renewal. With an initial injection of $2 trillion, the U.S. fiscal response had already far exceeded that seen in the wake of the 2008-2009 global financial crisis.
  3. Attractive value vs. bonds
    With bond yields down (and prices up), the gap in the value between stocks and bonds, as reflected in the equity risk premium, is wide. This suggests investors can potentially realize greater reward from stocks.
  4. Increased alpha potential
    Wide valuation spreads, the price-to-earnings (P/E) ratio of the cheapest stocks relative to the market average, means increased dispersion across individual stocks ― and opportunity for active stock picking to make a bigger difference in portfolios. The COVID-19 crisis has also accelerated some pre-existing trends, which should help to further propel growth companies that already had the wind at their back.

Reasons for caution

  1. Hidden vulnerabilities
    The lockdown-driven decline in economic activity and spike in unemployment has left the U.S. economy more exposed to risks. It remains to be seen whether there are any hidden vulnerabilities in the system, including hiccups in reopening progress. Markets do not like uncertainty.
  2. Risk of second wave of infection
    COVID-19 is a novel virus, meaning it has no exact precedent. A new round of infection is possible and its burden on the health care system and potential for renewed closures is unknown. The upside is that countries would enter a second wave wiser and more prepared, with availability of greater testing, contact tracing, protective gear and drug interventions.
  3. Heightened geopolitical tensions
    The U.S.-China relationship is further strained since the COVID crisis, defined by greater competition and less cooperation. Bouts of market volatility are likely should tensions flare. In addition, U.S. onshoring and the likely move toward deglobalization will have margin and inflation implications down the road.
  4. Absolute valuations are not cheap
    Stock prices are attractive relative to bonds, but by the most common measure of valuation, P/E ratio, they are not cheap. Stock prices relative to 12-month forward earnings per share stood at 21x at the end of May. Pandemic-related uncertainty has made the earnings outlook for many companies blurry at best.

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Tony DeSpirito
Tony DeSpirito
BlackRock Fundamental Active Equity Investment Team
Antonio (Tony) DeSpirito, Managing Director, is Chief Investment Officer, U.S. Fundamental Equities. In addition, he is head of the U.S. Income & Value Team ...