Take this opportunity: You can invest in a stock market that is currently heavily overvalued, but which could be only slightly overvalued next year if a lot of good things happen – at a time when a lot is happening bad things happen.
Are you in?
This is not a thought experiment. According to many analysts and fund managers, this is more or less the offer for anyone buying stocks today. Based on market performance, many investors take this.
The The S & P 500 rose 20 percent in the second quarter. Not over with the pandemic. With falling revenue. With increasing public debt. With unemployment at multi-decade highs and much of the economy still barely able to get up from the deck.
At some point, economic indicators and stocks were expected to recover as both declined after the pandemic broke out. However, skeptics warn that further progress on both issues may be much more difficult to achieve.
“We made the profits, now we’ve gone too far,” said Tobias Levkovich, chief equity strategist for the United States at Citi Research. “What happens to the tens of millions of unemployed? Retailers close shops. Where are these jobs going? “
Such questions could only be answered after the November elections if the course of government policy became clearer, said Levkovich. In the meantime, banks may be reluctant to lend and companies may be reluctant to take out loans.
“There is still a lot of uncertainty, including the elections, including how we are going to end the pandemic,” he said.
Saira Malik, head of equities at Nuveen, agreed that “there is a separation between the stock market and the economy”.
The good market news could be volatile, she said, when recent spikes in infection lead to a significant increase in hospital stays and deaths, and consumers are less likely to spend money when they are still unemployed and no new government stimulus payments are made.
But widespread trust in the Federal Reserve has strengthened the markets. The Fed announced its intervention in March simple monetary policy and the purchase of financial assets created with money from the air. Many strategists welcome the Fed’s short-term moves, but are concerned about the long-term impact.
“I’m not sure they could have done anything else in this scenario,” said Steve Kane, TCW bond fund manager. The Fed has signaled that short-term interest rates will remain close to zero for at least two years and has promised to buy a virtually unlimited supply of debt, from government bonds to exchange-traded high-yield bond funds.
The Fed may have been forced to try and support the economy for the time being, but Mr. Kane warned that “these measures are likely to be costly.”
“By not allowing the private sector to adequately assess risk, they will keep zombie companies alive,” he said. “This will result in a less efficient economy and less growth. Another thing that could happen is that if you have high structural unemployment and the government continues to spend, inflation could get to the other side. “
Another source of bullish sentiment is the willingness to ignore the sharp downturn and look “over the valley” new popular phrase did it, assessing the investment outlook based on predictions for a rosier environment after the pandemic.
The S&P 500 was trading at 24.4 times the analysts’ expected earnings of companies in the index this year compared to the average valuation of 18.8 times earnings over the past two decades. Using the 2021 forecast, which forecasts a profit increase of almost 30 percent, the index was traded at 19 times the profit.
This 2021 valuation would be little more expensive than the average of two decades, but a forecast is just that. While profits may recover strongly from today’s levels, which have been pushed down by the mandatory shutdown of much of the economy, there is no guarantee that this will be the case.
Whatever the valuations may be in the long term, they are sure to look high now and have never gone that low during the first quarter sell-off.
“Valuations were at their low in March 2020, regardless of the move, at any other bear market low of the past 55 years,” wrote James Stack, editor of the InvesTech Research Investment Newsletter, in a recent issue. “Not only that, but also the subsequent recovery of the market has exacerbated the existing valuation problems.”
When the stock market bubble, it expanded strongly in favor of fund holders in the second quarter. Morningstar’s average domestic equity fund rose an astonishing 21.7 percent, led by portfolios focused on industrials, consumer discretionary, natural resources, and especially technology.
Holders of international equity funds had to make do with an average increase of 19.7 percent. Specialists from Latin America and Asia did the best.
These accomplishments added to the overvaluation some analysts are warning. The risk is heightened by the possibility that the valley of economic growth and profits that the bulls are looking over is much wider than expected.
Economist at U.C.L.A. The Anderson School of Management said in a report that the pandemic was “in one Depression-like crisis. “They estimate that the economy will contract 42 percent annually in the second quarter, and predict that the lost ground will not be recovered until 2023.
It’s not just equity investors who ignore such warnings. The average fixed income fund rose 6.5 percent in the quarter, especially from those specializing in the most risky issues. High yield funds rose 9.4 percent and those holding emerging market debt rose 13 percent. Long-term government funding remained unchanged.
Although owners of secure government issues have not had much to show recently, Mr. Kane believes the prospects are better for them.
“You are not paid to take that risk,” he said. Treasury instruments will benefit, however, “if the Fed does what the market expects, has nothing to do with interest rates for a long time, and supports the market in the short term” by buying bonds.
But the near future won’t last forever. After economic and commercial life has returned to normal, the pandemic and measures to mitigate its effects may be felt for years, perhaps for decades. The Fed’s extraordinary measures are not the only potential cause of problems originating in Washington.
“We have seen a shared convention with an unconventional president create fiscal magnitudes that create budget deficits unimaginable for previous administrations,” said Chris Brightman, Research Affiliates’ chief investment officer.
He also fears that the extraordinary government stimulus and interventions in the economy during this crisis could be expected, in particular, by younger generations. “We will see Trillion-dollar deficits for years, ”he said.
All of this could mean higher taxes and consumer prices and much lower corporate earnings for years to come, he said. And since American stocks already have higher valuations than other markets, “there is a potential opportunity for those who want to limit US equity investment.” and invest more abroad, he said.
Ms. Malik von Nuveen prefers foreign and domestic stocks, but only high quality stocks.
“Companies with strong free cash flow and stable balance sheets will continue to outperform,” she predicted.
Her recommendations include economically sensitive Japanese companies, the American technology industry, companies that are growing slowly and steadily and continuously increasing their dividends, as well as companies worldwide that are ranked according to environmental, social and governance criteria.
It would also take a chance on higher-value stocks in emerging markets that developed long before the pandemic, such as Brazil. It is difficult for ordinary investors to find such stocks. It therefore proposes to do this through actively managed special funds with a good track record.
Mr. Levkovich from Citi Research would focus on market segments that would benefit from modest but not spectacular economic growth. He believes banks, healthcare, semiconductors, and technical hardware are doing well, but would limit exposure to industries like energy that are more economic and have performed particularly well, perhaps too well, lately.
Mr. Kane likes Banks, also. Their financial strength, as they continue to be healed from the self-inflicted violations of the financial crisis, makes their bonds suitable assets, as do those in more secure areas such as consumer staples.
He believes that high quality will come in handy when companies find that they need all the help they can get when the virus and recession go through their courses, even if you didn’t know how Stock market has behaved.
“Certain companies will simply not be able to go back where they were,” he said. “Unemployment will continue to rise. This affects business behavior, consumption and savings. The economy will disappoint the optimistic assumptions that largely flow into asset prices. “