Have markets distanced themselves from the economy?


Anthony Saglimbene, Ameriprise Global Market Strategist

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As of May 18, 2020

Looking back

  • In April, U.S. stocks posted their best monthly performance in more than three decades.
  • The U.S. economy contracted quarter-over-quarter for the first time in six years.
  • More than 20 million Americans lost their jobs last month.   


Up ahead

  • An increasing number of states are reopening for business and relaxing stay-at-home orders.
  • Stocks are looking ahead to a slow, choppy economic recovery to start in the second half of the year, with variation across regions.
  • Investors should maintain modest return expectations.

 

Markets are pricing in better days ahead

After tumbling roughly 34% from its market top in March, the S&P 500® Index finished its best April in more than 30 years, rising 12.8% on a total return basis. Cyclical areas like energy, consumer discretionary, materials and technology charged higher, as market optimism grew over reopening the U.S. economy. International stocks also posted solid returns in April, seeing their best month since 2009.

Despite the stock market's optimism, the U.S. Department of Commerce reported that gross domestic product (GDP) contracted 4.8% in the first quarter. Additionally, the U.S. economy lost a staggering 20.5 million jobs in April, as the unemployment rate skyrocketed to 14.7% from 4.4% in March. April's unemployment rate surpassed the post-World War II record high of 10.8% in November 1982.

Importantly, the S&P 500 in 2020 is down roughly 11% — during a global pandemic, in a country that is still primarily locked down and amid some of the worst economic conditions in modern history. Manufacturing and services activity has ground to a halt, and COVID-19 has thrown corporate profits and business visibility into a tailspin.

First quarter profit reports have been negative, and we expect earnings to be even worse in the second quarter. Current analyst estimates call for S&P 500 earnings per share (EPS) to decline by roughly 40% in the second quarter. This, coincidentally, is how much we believe the U.S. economy could contract in Q2.

Given the pressured state of current and near-term conditions, some may ask, “Why have stock prices shown so much resiliency?”

Below is our take on the stock market's strength given these unprecedented times:

  1. In our opinion, stocks have not distanced themselves from the economy. Instead, markets are pricing in a recovery beginning in the second half and an economic backdrop that looks materially better than it does now. Simply put, the market’s worst fears have not materialized, and for now, it believes the future will be brighter than the present.
  2. The U.S. Federal Reserve backstopped the economy and Congress rose to the occasion when required to do so. Fed lending programs and other accommodative measures combined with government aid packages could help small businesses and consumers hang on until more of the economy reopens. The willingness of the Fed and Congress to do more if needed also increases the chance the economy will eventually navigate its way through this crisis.
  3. Importantly, the "market" is not nail salons, hairdressers, local retailers, and restaurants. Across these smaller businesses, the outlook is less certain. But S&P 500 companies and even many companies in the Russell 2000 Index are significant public entities, with ample access to credit and liquidity.
  4. Several of the largest S&P 500 constituents have seen their business trends improve or have avoided a significant disruption during the economic shutdown. Big tech companies account for more than 20% of the index. In several instances, these companies saw improved business trends due to work-from-home/stay-at-home policies, which drove increased online, cloud computing, browsing and shopping traffic. The S&P 500's top-heavy allocation to companies that have maintained a dominating edge through the uncertainty is one reason the U.S. stock barometer has remained so resilient this year.
  5. Lastly, the outlook for a COVID-19 treatment or vaccine in 2020 has improved. As a result of a government-sponsored program to speed the development of a virus vaccine and notable positive trials on Gilead Science's Remdesivir treatment, markets have moved higher over recent weeks. Stock prices, in some respect, currently reflect a back half of the year outlook, where consumers reduce their social distancing behaviors and are less fearful of going out in public.

Combined, we believe the dynamics outlined above contributed to the overall resiliency across the stock market. But for now, we have muted return expectations through year-end. Investors need a clearer picture of how well the economy reopens and how virus trends progress downward.

If the market's more optimistic view of recovery begins to take shape in the second half as expected, we believe stocks have more upside room from here. However, given the uncertainty of the situation, risks are skewed to the downside, in our view. Importantly, markets may have a harder time looking to a brighter future if the economic and corporate evidence continues to point toward a harsher reality.

Stay focused on your strategy and reach out to an Ameriprise advisor with any questions or concerns about your portfolio.

All performance, economic, and earnings data sourced from FactSet unless otherwise stated.

    

Data source: Morningstar Direct, as of May 8, 2020
Past performance is no guarantee of future performance