Stimulus stalemate and stocks

A perspective from E*TRADE Securities 10/29/20

After successive massive stimulus packages helped lift the US economy—and stock market—from the depths of the downturn earlier this year, negotiations surrounding additional fiscal aid have dragged on for months. 

A main point of contention is the size of the next package. Lawmakers have gone in circles proposing various versions of a bill that may (or may not) include another round of direct payments to Americans, loans for small businesses, aid for ailing industries, and support for particularly hard-hit cities and states. 

The election has only heightened the bitter bipartisanship on Capitol Hill, as both sides fall short on compromises in hopes of more clout post-November 3.

Stocks have stumbled as talks recently appeared to have ground to a halt. With a package seemingly unlikely to be delivered in the immediate future, what are the potential implications for the market?

Stocks struggling to find direction

Since reaching its current record high on September 2, the S&P 500® has struggled to find direction. The absence of fresh stimulus measures, coupled with uncertainty surrounding the election and the course of the pandemic, has put a damper on the rally that took off at a record pace in April. Some market watchers worry that without more stimulus, the economic recovery may stall, which could in turn change the trajectory of the market.

Source: FactSet Research Systems

Stimulus across the market

But the rising tide brought by additional stimulus—or in the present case, the potential for future stimulus—may not lift all sectors equally.

Here’s a look at some of the areas that may be most sensitive to on-again, off-again negotiations:

  • Airlines: It’s no secret that air travel has fallen off a cliff this year, and the industry may not see demand pickup to anywhere near pre-pandemic levels until a vaccine is available. Cash-strapped airlines have pleaded for additional aid to help support their massive workforces, and a few have already proceeded with laying off thousands of workers. The potential for government stimulus has been a driver for the airline sector in recent months, and without it these stocks may continue to suffer.
  • Discretionary stocks: Consumer confidence dipped in October, reflecting less optimism about the future of the economy. A prolonged delay in aid for individual Americans may affect how households choose to spend (especially if jobless claims remain elevated), which could be critical for some consumer discretionary stocks—especially heading into the holiday season.
  • Small caps: Small-cap stocks tend to be cyclical, meaning their businesses usually ebb and flow with the economy. While the economic recovery has certainly come a long way, some analysts may see the absence of more stimulus as a potential headwind for cyclical areas of the market. The small-cap Russell 2000 index is still negative year to date, compared to the S&P 500’s roughly 1.3% gain.

Other pockets may be less dependent on the next package:

  • Technology: The tech sector has performed remarkably well this year, and many of these companies continue to have an edge in the digital-driven economy that has only become more important in the age of COVID (although the high valuations in some of these stocks could make them susceptible to pullbacks).
  • Housing stocks: The pandemic appears to have been a boon for the US housing market, which is red hot thanks in part to record-low mortgage rates, tight supply, and high demand. A strong housing market may factor into solid performance among related stocks such as homebuilders, real estate developers, listing agencies, and home-improvement companies.
  • International equities: While US stocks are outperforming their global peers year to date, some market watchers have highlighted the potential for foreign equities, especially if the dollar weakens further. A weaker dollar means (at least some) other currencies are stronger, boosting the value of stocks that are traded in those foreign currencies.

Bottom line

Navigating the current environment hasn’t been easy, but the good news is we may have more clarity on the timing and size of the next stimulus package in the coming weeks. Diversifying a portfolio across asset classes and investments is the fundamental framework for a long-term investing strategy and can help provide guardrails when all else fails. 

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