Stocks’ Rally Hits Roadblock With Worst Drop Since Mid-March - Butler Financial, LTD
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Stocks’ Rally Hits Roadblock With Worst Drop Since Mid-March

Equities suffered a heavy single-day decline amid rising jobless claims and continued coronavirus concerns.

The equity markets and the global economy have been shaken, and this week saw the markets’ best sustained rally since the ’30s dissipate in just a few hours, while gross domestic product continues to decline and COVID cases continued to rise in key areas. At one point, the S&P 500 had made up for this year’s losses – only to post its worst daily decline since March on fears of a second wave of coronavirus cases (several states have seen upticks of late), an additional 1.5 million jobless claims and the potential impact on domestic and global economies, explained Chief Investment Officer Larry Adam. The uncertainty surrounding the availability of a potential vaccine compounded already low investor sentiment.

“Elevated levels of optimism and great expectations of a strong economic and earnings rebound are being met with a dose of reality,” Adam said. “However, we remain optimistic over the longer term.”

Senior Portfolio Strategist (Equity Portfolio & Technical Strategy) Joey Madere concurs, saying, “We continue to view the positives, such as an enormous fiscal and monetary response, as outweighing the potential negatives (e.g., the election, U.S./China trade rhetoric, virus resurgence).” As such, investors may want to accumulate favored sectors and stocks as this pullback plays out.

Progress has been made in curtailing the spread of COVID-19, yet as the majority of states reopen and large gatherings from protests continue, there’s the potential of a second wave of the virus. Although another national stay-at-home order is unlikely, according to Healthcare Policy Analyst Chris Meekins, continued upticks in cases could lead to worsening health outlooks and stronger mitigation measures in affected regions.

Whether we’ll see an additional round of stimulus out of D.C. remains to be seen, adds Washington Policy Analyst Ed Mills. “Back to work” is emerging as the theme of the next congressional fiscal relief package, but the direction of the economy and the trajectory of the virus will weigh significantly on the debate. For now, lawmakers anticipate short-term additional economic support with the launch of the Federal Reserve’s Main Street Lending Program, which could provide hundreds of billions in loans to midsized businesses left out of the previous government aid programs. The larger questions for the next congressional package revolve around aid to significantly affected sectors, extensions of expiring individual support (e.g., eviction protection, unemployment insurance), additional tweaks to small business lending, and whether more direct payments are necessary.

Here is a look at some key factors we are monitoring:

Economy

  • Following its June 9-10 policy meeting, the Federal Open Market Committee left short-term interest rates unchanged and kept its asset purchase plans in place. Officials expect a gradual economic recovery and see no change in interest rates through 2022 – an outlook similar to those of private-sector economists, but disappointing for financial market participants.
  • While the National Bureau of Economic Research declared that the economy entered recession in February, it’s likely that the economy bottomed in April, explains Chief Economist Scott Brown. The job market picked up in May, motor vehicle sales improved, and many of the other monthly economic indicators are expected to show sharp improvement as state economies reopen. However, the May rebound came after very steep declines in March and April. Absent a vaccine or effective treatment against the coronavirus, a full economic recovery will take many quarters.

Equities

  • Volatility has crept back up in recent days. Strength from technology stocks masked some of the internal deterioration this week, as the Nasdaq composite was able to break out to new all-time highs, while the average S&P 500 company traded 7% lower.
  • Pullbacks are to be expected, says Madere, especially following the extremely rare up-move experienced over the past 50+ days. He notes that 2009, 1982 and 1975 periods were the only three instances with 25%-plus gains in a 50-day period since the 1930s – all of which were experienced coming out of recessionary bear markets and were followed by short-term pullbacks within the next month or two. Importantly, they all then experienced above average returns over the ensuing 12 months.
  • This pledge to keep rates low and the caution around economic growth from the chair of the Federal Reserve has been damaging to equity markets, explains Chief Fixed Income Strategist Kevin Giddis. What we have learned this week is that there is a cost to reopening the U.S. economy.

Bottom line

  • The equity market should climb higher over the next 12 months or so, Adam believes. Disappointments could lead to further downside volatility. Patience and a focus on asset allocation remain imperative in his view.
  • Recent volatility can be viewed as a needed (and healthy) consolidation for the market to digest its gains, so the fundamentals can begin to catch up to price. While opportunities exist, they come at various levels of risk for both stocks and bonds. Patience and caution are warranted.

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of Raymond James and are subject to change. Economic and market conditions are subject to change. The S&P 500 is an unmanaged index of 500 widely held stocks. An investment cannot be made in this index. Sector investments are companies engaged in business related to a specific sector. They are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification.

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