The big-time potential of small cap stocks [PODCAST]
Pinpointing winners requires a sound investment process.
Pinpointing winners requires a sound investment process.
3rd Quarter 2020 Market Outlook
Financial markets staged a stunning recovery in the 2nd quarter, despite the swift economic recession wrought by the COVID-19 pandemic.
Widespread, intuitive and highly logical expectations were that the markets would struggle in a best-case scenario and collapse in a worse case scenario. However, markets frequently do not follow intuitive scripts. The 2nd quarter results are an extreme example of markets going “off script.”
Since the market low of March 23, 2020, the S&P 500® and Dow Jones Industrial Average indices are both up approximately 35%, while the technology-oriented NASDAQ index continued its dominating performance, up over 40%. Even long-lagging international stocks were up strongly, with the MSCI EAFE Index, which tracks developed-economy stocks in Europe, Asia and Australia, was up over 30%.
New bull markets begin well before the onset of economic recovery following a recession. However, an economic recovery and ancillary improvement in corporate earnings is required to validate a new bull market. Currently there is much uncertainty as to the shape and speed of a recovery.
The National Bureau of Economic Research (NBER) declared the U.S. officially in recession as of February 2020, ending one of the longest economic expansions on record. This was a relatively quick pronouncement compared to prior recessions. However, it should be noted that there were signs of economic weakness well before the arrival of a government mandated economic shut down. The question we now face is, when will it be over?
The best case is for a “V” shaped recovery – one in which economic activity (especially jobs) snaps back to previous levels. The financial markets have been acting in a manner consistent with expectations of a “V” shaped recovery. Some recent statistics have suggested the “V” shaped option may be plausible.
A significant turnaround in jobs, which is a necessary condition for sustained economic recovery, has shown signs of developing. Retail sales and consumer confidence have also been improving faster than expectations.
Although these early signs of fundamental improvement are encouraging, it should be noted that the market recovery has been largely enabled by huge doses of “therapeutic” liquidity administered by the Federal Reserve (Fed), other central banks and the U.S. Congress.
A more prolonged or “U” shaped economic recovery still seems more likely given the slow normalization process that both consumers and businesses now face. The Fed appears to have an economic view that supports the “U” shaped recovery outlook. Its forecast is for sustained high unemployment well into 2022 as businesses and consumers adjust their behavior to the ongoing challenges of dealing with COVID-19. The Fed’s words and actions remain very cautious, yet are committed to providing every therapy measure necessary to foster a sustained and durable recovery.
Here is what we currently know – and don’t know:
The most significant factor in the near-term outlook is the impact of reopening the economy. If there is an unacceptable continuing acceleration in infection, regardless of government policy, people will react, and economic activity will stall. Thus far, the economic evidence has signaled a more optimistic outlook.
Other risks will play out over time, but in the near term, one should not underestimate the power of central bank policies on asset values. Also, both monetary and fiscal policy makers have been following the “play book” that came out of the financial crisis of 2008. They have augmented the potency of specific policy levers to great effect.
We remain cautiously optimistic that policy steps taken have been and will continue to strongly support economic growth, barring a severe resurgence in the pandemic.
Generally, asset valuations are quite full, particularly in the context of the uncertainties caused by this unprecedented environment. The U.S. markets, particularly defensive sectors, remain “rich” relative to value, cyclical and small cap sectors.
However relative valuation alone isn’t enough to downplay the defensive, stable growth sectors of the market. They remain highly valued given their superior operating performance and business characteristics that have proven to be durable and successful in an environment of uncertainty. Value, small cap, and international markets are leveraged to a sustained acceleration in economic growth.
There are some intermittent signs that these sectors may deserve more exposure in portfolios, but additional evidence is necessary to validate continued rotation into these economically sensitive areas.
All information and representations herein are as of 07/02/2020, unless otherwise noted.
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.
Any indexes shown are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.
Past performance is not necessarily indicative of future results.