Dear Clients and Friends:
Before proceeding with our outlook, we’d like to inform our readers that we recently refreshed our social media presence and invite you to follow us on Twitter, Facebook, and LinkedIn for our regular thoughts on the market.
We are at the midpoint of 2020, and it would be an understatement to say it has been a challenging year so far in the United States and around the world. We’ve faced health, social, and economic crises that continue to impact our communities and our economy. We remain optimistic in the long-term prospects for the US economy and expect to come out stronger for having faced these challenges. In the short-term, there remains an elevated level of uncertainty which we believe warrants caution.
As countries around the globe have re-opened from their virus-induced lock-downs in the spring, we’ve seen a sharp improvement in economic data, in many cases exceeding expectations. In particular, US jobs and retail sales data came in strong in May and June. This has helped fuel markets higher on hopes the economy can experience a “V” shaped recovery. However, we see several headwinds ahead that could result in a recovery that is uneven and ends up taking longer than many investors anticipate.
The recent surge in COVID-19 cases in the US, especially in heavily populated states such as Florida, Texas, and California, have resulted in re-imposed restrictions on individuals and businesses, thereby slowing down the planned re-opening. And even though progress has been made on a vaccine, it is unlikely to be fully tested and widely available before the next cold and flu season. The realization by consumers that the virus will linger may negatively impact spending in coming months as they prefer to take a cautious approach to their activities and interactions. In addition, government stimulus is beginning to fade, especially for those collecting unemployment benefits as they will lose an extra $600/week at the end of July (this benefit is likely to be extended in some form but with a lesser amount). These factors increase the odds of economic data disappointing investors and causing a shift in sentiment.
While the broad market indexes have experienced a strong rally over the past 3 months, the participation across asset classes, sectors and stocks has been limited. For example, roughly 30% of the gain in the S&P 500 since the March lows can be attributed to just six mega-cap technology stocks (Facebook, Apple, Netflix, Microsoft, Amazon, and Google). This narrow participation has been highlighted by a low number of NYSE stocks hitting new 52-week highs, a sign the rally could falter if it does not soon broaden. Small-cap stocks and cyclical sectors such as industrials, financials and energy have not yet provided the type of leadership that is expected in the early stages of an economic recovery.
From a valuation perspective, the market appears expensive given the dramatic decline in earnings due to the lock-downs and lack of economic activity for much of the last quarter. FactSet’s consensus S&P 500 EPS estimates are calling for a 44% year-over-year decline in the second quarter, marking the largest such decline since Q4 of 2008 (-69%). From here, analysts predict smaller year-over-year EPS declines in the 3rd and 4th quarter before returning to earnings growth in Q1 2021. Based on 12-month forward estimates, the S&P 500 is trading at nearly 23 times earnings, well above both the 5-year average (16.9) and 10-year average (15.2). Further clouding these estimates is the fact that many companies are choosing to withhold forward EPS guidance due to the uncertain economic outlook.
The upcoming US election will soon become more of a focal point to investors and its policy implications for the economy (taxes, regulation, fiscal stimulus, etc.). The President’s approval rating has suffered over the past several months based on voter sentiment of his handling of the pandemic and other key issues. Thus, it appears the election will be highly contested and likely to impact markets. Interestingly, the performance of the market during the months leading up to the election may provide clues to the eventual winner. Going back to 1928 with an 87% success rate, if the S&P 500 is higher in the three-month period before the election, the incumbent party has won. Conversely, if stocks sell off ahead of the election, the opposition party has prevailed.
As the market has rallied in recent months, we have taken the opportunity to shift portfolios to a more defensive posture. Given the aforementioned risks and uncertainties, we are focused on finding ways to protect on the downside should we experience an increase in volatility in the months ahead. Additionally, we have been careful in our stock selection to own high quality companies at attractive relative valuations with strong balance sheets and consistent free cash flow that can weather this challenging environment.
Should you have any questions about your portfolio, please let us know.
Gallacher Investment Committee
The opinions voiced in this report are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult Gallacher prior to investing. All performance referenced is historical and is no guarantee of future results. Economic forecasts set forth may not develop as predicted. Research material prepared by Gallacher. Research material prepared by LPL Financial and Gallacher.
Gallacher does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Gallacher cannot guarantee that the information herein is accurate, complete, or timely. Gallacher makes no warranties with regards to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
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