Market Outlook

September 30, 2020

Be Ready To Ride Out A Couple Of Potentially Volatile Months


John Boyd

From their March Covid lows through August, stocks staged one of the quickest and strongest rebounds in market history. However, in September, that advance hit a wall with the S&P 500 losing 3.8% in volatile trading. Since 1928, September has been the worst-performing month of the year for the S&P 500, with an average loss of 1.0%. But clearly more than just the turn of the calendar was at work in halting (for now) the advance, and some of these factors seem likely to continue to buffet the market for the next couple of months — at least until the election and perhaps further.

Fear Over Rising Covid-19 Cases

Since the early days of the pandemic, we’ve been warned that, like the various strains of the common flu, Covid-19 infections may increase significantly during the colder months in the northern hemisphere. Indeed, to take one example from the southern hemisphere, Australia had an initial surge in cases in March/April (its fall) and then a second, larger wave in June/July/August, its winter. Combine that with rising cases as restrictions are eased further and we may be reminded that this pandemic is far from over. Indeed, much of Europe is experiencing a new surge in cases and they have moved a bit higher here at home, as well.

Lack Of A Second Stimulus Package

The injection of cash to individuals (and businesses) from the passage of the two-trillion-dollar CARES Act back in March was key to avoiding a worse economic downturn. In fact, consumer spending actually increased as the recession took hold! However, the provisions of that act expired at the end of July, including the extra $600 per week for those unemployed. Fed Chair Jerome Powell has argued strongly that a second stimulus bill is needed now as the strong rebound in the economy we saw initially has started to wane in some areas (notably employment). Yet Democrats and Republicans have been unable to reach a compromise on the size of a new bill. An agreement before the election seems unlikely now that the focus of Congress has shifted to the confirmation battle over Amy Barrett, Trump’s pick to fill Ruth Bader Ginsburg’s seat on the Supreme Court.

More Bricks In The Wall (Of Worry)

There is no shortage of other, less direct, concerns that are contributing to a general uncertainty and unease. We are in the midst of waves of social unrest throughout the country and geopolitical (i.e. China) tensions are also on the rise. The election is looming and there is a possibility that we may not know the winner for some time after November 3, thanks to expected large numbers of mail-in ballots. To muddy the waters a bit further, President Trump recently refused to commit to a peaceful transfer of power should he lose the election.

Longer Term Outlook Positive

Any or all of the above worries may well make the next few months difficult, but bull markets tend to “climb a wall of worry,” and I believe the stage is set for a continuation of the upward trend by the end of the year, if not before.

Once the election is over we should see the passage of a second stimulus act. Progress on a vaccine continues apace with 9 candidates now in phase 3 trials — the last step before approval. If all goes well, we could see frontline healthcare workers receiving a vaccine before the end of the year and high-risk individuals by early next year and the general public perhaps by mid-year.

Many areas of the economy are still rebounding strongly. Housing is on an absolute tear, with sales of new home sales in July and August running nearly 50% higher than a year ago and reaching levels not seen since 2006! New orders for capital goods (non-defense and ex-aircraft) have risen sharply since April and are now at the highest level since July of 2018.

The service sector remains a weak spot and initial claims for unemployment (much of it service-related) have stalled at just under 900,000 per week compared to a little over 200,000 before the pandemic began. However, once the virus is contained, the service sector should rebound quickly.

Valuations Better Than They Look?

One of the arguments against stocks has been the high valuation of the S&P 500 with a 12-month trailing P/E of 24.8. In my August Outlook, when the P/E was 26.8, I noted that the last time it was that high was when we were just coming out of the financial crisis in 2009, at the beginning of the longest bull market in history. Well now James Paulsen, Chief Investment Strategist at Leuthold Group, has put some rigor behind that thought. He developed what he calls the “output gap adjusted P/E.” In economics, the “output gap” is simply the difference between the current GDP and its estimated level if we were at full employment. In times of high unemployment like today, while the actual P/E can be quite high, the adjusted P/E measure can be quite low — in fact, it is in the low single digits right now. Paulsen, notes that since 1974, every time the gap adjusted P/E has been this low, a bull market ensued that lasted for several years.

So stay calm as the year winds down and don’t fret if the market is volatile over the next couple of months.


 — John M. Boyd