Can the market hold its high note?

A perspective from E*TRADE Securities 08/27/20

On August 18, the S&P 500® seemingly put the worst of the coronavirus market crash in the rear-view, recouping the last few points to hit a new record high. The index has staged a remarkable recovery since its March low, gaining more than 50% over the past five months. 

The optimism in the market has been hard to quash, despite a tough economic reality for many. Even the cautionary outlook voiced in the Fed’s latest meeting and an unexpected rise in weekly jobless claims haven’t dampened sentiment.

Investors have likely heard the phrase “the stock market is not the economy” more than once in recent months. While those words certainly appear to hold weight given present circumstances, many may find themselves wondering how the market can be flying high while millions of Americans are out of work and many businesses still have yet to fully reopen—and, of course, whether the rally can last. 

The focus is on the future

First, the stock market is forward-looking. It reflects what investors expect the economy will look like in the future, not necessarily how things look at present. The economy may still be struggling, but many market watchers appear to believe the worst of the contraction is over. Three potential factors that may buoy optimism for a rosier future:

  • Hope for a vaccine. With 31 candidates in clinical trials,1 markets are seemingly pricing in the likelihood that a vaccine will be available sooner rather than later. Given the flurry of headlines surrounding the progress, investors may be looking to get into the market before a vaccine is officially approved, with the expectation that many stocks may be lifted by the return of some normalcy in daily life. It is important to keep in mind, though, that the availability of a vaccine is just the beginning of the end of the coronavirus, best case.
  • Anticipation of another stimulus package from Congress. While negotiations have stalled, analysts generally expect both parties will ultimately reach an agreement to get the economy and individual Americans more aid.
  • The Fed. The Federal Reserve has unleashed unprecedented monetary stimulus and committed to maintaining near-zero interest rates until the economy is on firmly on the mend—a “whatever-it-takes” stance that some market watchers feel will continue to support the market regardless of how other factors play out.

Big tech gains have lifted the broad market

A significant portion of the market’s recovery thus far is due to the success of a few technology giants that have fared incredibly well in the stay-at-home era. Amazon, for instance, is up roughly 75% year-to-date, Apple is up nearly 60%, and Microsoft has gained more than 30%. Considering just five companies—Amazon, Apple, Microsoft, Facebook, and Alphabet—account for more than a fifth of the S&P 500’s market value,2 the rally in these stocks has given a considerable boost to the broader market. 

But the bullishness behind tech isn’t just wishful thinking—these companies have been able to deliver expectation-topping results3 in a world that has come to rely on their services from the comfort of the living room. The tech sector in general has thrived in this new norm. Just take a look at the Nasdaq Composite (which is approximately 50% technology by weight). The index has almost quadrupled the S&P 500’s return this year. 

Source: FactSet Research Systems


And as more of our everyday lives become dependent on technology—whether through work, school, shopping, even physical fitness—much of the industry, and the areas that support it (digital infrastructure, communications, cloud, security), may be positioned for long-term growth.

What about the economy again?

To be sure, since March, the US economy has suffered one of its steepest downturns since the Great Depression. A decade’s worth of job gains was erased, unemployment reached the highest level of the past 70 years, and second-quarter GDP plunged by the largest percentage on record. 

But there are signs that things are improving, including downward trends in jobless claims and the unemployment rate. Some pockets of the economy (ahem, the housing market) have actually been unexpectedly strong, giving investors a source of relatively good news amid the COVID chaos.

Meanwhile, after a spike in July, daily new coronavirus cases are falling across the country, helping allay fears of a reversal in recovery progress. 

Investing considerations

Of course, none of this is to say there isn’t the possibility of another crippling wave of infections, a full-blown trade war with China, a delay on the vaccine front, or any other number of risks. But it does offer some perspective on what has driven the market to new heights and whether the rally is justifiable. Here are a few other things investors should keep in mind:

  • Tech isn’t the entire market: Take away the returns of Amazon, Apple, and Microsoft, and the total return of the S&P 500 through the end of July would have been -4% (vs. a 2.4% gain).4 While tech is certainly flexing its muscles, being overly concentrated in any one sector presents risks of its own.
  • The power of the American consumer: Some major US retailers recently crushed earnings expectations, thanks in large part, to a resilient consumer.5 Good news for an economy that relies on said consumer for 70% of activity.
  • Lessons learned: It’s been a while since we’ve been in the throes of the day-to-day volatility that defined the market earlier this year, but that doesn’t mean investors should write it off—especially as we approach the November election. Diversification and cool-headedness are virtues.

It may be nice to welcome the bulls back to town, but above all, investors would be wise to stay the course and keep investing decisions focused on individual timelines, long-term goals, and risk tolerance.

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  1. World Health Organization, Draft landscape of COVID-19 candidate vaccines, 8/25/20, https://www.who.int/publications/m/item/draft-landscape-of-covid-19-candidate-vaccines
  2. The New York Times, “Big Tech’s Domination of Business Reaches New Heights,” 8/19/20, https://www.nytimes.com/2020/08/19/technology/big-tech-business-domination.html
  3. The New York Times, “They Made How Much?” 7/31/20, https://www.nytimes.com/2020/07/31/business/dealbook/tech-earnings-economy.html
  4. The New York Times, “‘This Market Is Nuts’: S&P 500 Hits Record, Defying Economic Devastation,” 8/18/20, https://www.nytimes.com/2020/08/18/business/stock-market-record.html
  5. Bloomberg, “Americans Surprise Wall Street With Spending Boom During Coronavirus,” 8/19/20, https://www.bloomberg.com/news/articles/2020-08-19/wall-street-underestimates-u-s-consumers-and-their-wallets

 

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