The stock market closed on August 18th with the S&P 500 hitting a new record, surpassing its previous high set almost six months to the day on February 19, 2020. Over this period stock investors have experienced a rollercoaster ride spurred by the COVID-19 pandemic.
A key driver of the S&P 500’s V-shaped rebound has been the significant fiscal and monetary stimulus deployed by Congress and the Federal Reserve. Additional unemployment benefits, economic stimulus checks and Payroll Protection Program (PPP) loans, among others, have helped replace the demand shock caused by a sharp uptick in unemployment and social distancing measures. In addition, the Federal Reserve has aggressively grown its balance sheet through its Quantitative Easing program, which has largely been centered around purchases of Treasury bonds and mortgage backed securities. The low absolute yields in these securities has shifted some investors into riskier assets, such as stocks, as they look for the opportunity to earn higher returns.
In the investment community, returns are often assessed over a market cycle or on a peak-to-peak basis. In this case, peak-to-peak returns occurred over an abbreviated six-month period. Unfortunately, the COVID-19 virus is not yet a thing of the past and we caution investors to not look at the new high as an indication that the market is past the pandemic. It is clear that the government efforts to soften the economic toll of the crisis have proven fruitful, but they have also pulled forward future returns.
We remain optimistic about the opportunities ahead but recognize this chapter of the history books is not yet complete. Uncertainty around the progression of the virus, government responses to any potential outbreaks and the evolving spending patterns of consumers and businesses are all variables that can’t be predicted with certainty. On top of that, we are encroaching upon what is likely to be a hotly contested election. Any of these variables can add volatility and some level of downside risk to the equity market.
Looking ahead, the next six months could be a bit different than the last six months. Companies will adapt to changing circumstances. Market preferences will evolve, as they always do. We see the coming environment to be one where there will be greater divergence in the performance of stocks. As such, portfolios are likely to be more sensitive to the returns of the underlying stocks and less impacted by how the broad market has done. We have been proactively positioning portfolios to participate in what we expect to be a ‘stock pickers’ market ahead.
Looking back at what has been an incredible six-month period in the market, we caution investors to not view a new record high in the market as time to wave the checkered flag on the downturn. Risks remain, but opportunities do as well.