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Review the latest Weekly Headings by CIO Larry Adam.

Key Takeaways

• Robust Recovery Is The General ‘School Of Thought’
• Investors Hope A Second Wave Is ‘The Road Not Taken’
• Valuations Require Investors To ‘Put Their Thinking Caps On’

Congratulations to the Class of 2020! I must admit, when I pictured my eldest daughter graduating high school, I did not imagine her wearing a mask with her cap and gown while receiving her diploma in my backyard. Although the traditional festivities did not occur, I can say that she, along with all other graduates, are moving onto college or entering the work place with valuable lessons in hand. From adapting to online learning to enduring the uncertainty that life can throw our way, this class has displayed incredible resilience and we wish them the best of luck in their future endeavors. Resiliency also comes to mind when I think of the US equity market. COVID-19 resulted in one of the swiftest declines in history, but the rally has been historic too. Before yesterday’s pullback, the S&P 500 was up ~43% and even briefly turned positive on the year. Due to inflated optimism and the market pricing in an exorbitant amount of positive news, the uptick in volatility had been expected.

• The Bottom Line | We still believe the future looks bright for equity investors, but ‘great expectations,’ especially pertaining to the successful reopening of the US economy and the eventual development of a vaccine, may be what hampers its near-term performance. The weight of these expectations has caused us to enter a ‘show me’ phase of the market, where both economic growth and earnings are going to have to meet, if not exceed, elevated estimates already priced into the market. Any further disappointments regarding the strength or speed of the recovery could exacerbate interim periods of downside volatility.
• Rebound Expectations May Be Reaching For The Stars | The equity market is a forward-looking mechanism, anticipating any economic developments or market-moving events that could potentially occur over the next three to six months. Therefore, current equity market levels are in part a reflection of the expectations surrounding the severity and duration of the virus-induced recession and the impending recovery in the second half of this year. As the fears of the virus intensified and states implemented full lockdown restrictions, a significant decline in economic growth became inevitable that led the S&P 500 to decline ~34% to its recent lows on March 23. However, as states appeared to be successfully lifting restrictions, estimates for a vigorous bounce back in economic activity in 2H20 strengthened and buoyed the recent rally. It was revealed this week that the current consensus estimates for third and fourth quarter GDP (~20% and 9%, respectively) are higher than those predicted by the Federal Reserve (Fed). These heightened expectations have put pressure on the US economy to grow significantly faster in order to propel the equity market higher, which is why the threat of a second wave of cases induced Thursday’s sell-off. A quick return to work for the majority of the 44 million workers who filed unemployment claims may help the dream of a remarkable rebound become a reality, but there are still many risks that could prevent it from happening.
• Oh The Places The Equity Market Could Go (With A Few Surprises) | As the virus spread throughout the US and as the economic outlook deteriorated, both the Fed and Congress immediately intervened. The speed and precision with which both entities acted, combined with the overall size of the lending and aid provided, caught the market by surprise. The Fed is expected to hold interest rates at zero through the end of 2022 and Congress is expected to pass additional stimulus over the next month, but beyond these measures, it is difficult to imagine what, if any, additional positive ‘surprise’ actions could be taken. Any delays or smaller-than-expected packages could be a ‘negative’ surprise. Therefore, the equity market may need a surprise ‘positive’ catalyst, such as another advancement in the vaccine or therapeutic research, in order to move higher.
• Valuations Reflect Big Hopes And Dreams | Recent equity market returns have been overwhelmingly driven by optimism, and the positive news contributing to the rally has led valuations to rise to the highest levels since 2001. Investors still have high hopes for a robust economic recovery and big dreams that the seemingly promising clinical trials will lead to the eventual development and mass production of a vaccine for the virus. Since these occurrences appear priced in, the equity market is inherently vulnerable to pullbacks. The thought that a second wave of COVID-19 cases could jeopardize the later stages of states reopening did exactly that this week, and additional risks still remain. On the political front, President Trump’s approval rating fell to 39% (Gallup Poll), increasing the uncertainty of his re-election prospects and the potential rollback of his tax cuts. On the geopolitical front, renewed tensions between the US and China reignited fears about trade. Even so, pullbacks are usually a healthy test for the equity market, and often present a buying opportunity for long-term investors. However, with valuations still elevated, ‘knowledge’ regarding the potential magnitude of outstanding risks ‘is power.’

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All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. Past performance may not be indicative of future results.