A NEW CYCLE – 2020 and after
A lot has happened in the financial markets. The never-ending "Jumanji" 2020 year has had plenty of unforeseen events. Still, the game is not over. The real fun looks like it is about to begin in this last quarter.
The third quarter of 2020 had a substantial recovery for financial markets and steady healing for the main economy. So far, the year the performance until the Q3, S&P 500 index's was up SPY +9.35%, the technology stocks Nasdaq was up +35.10%, and the broad US fixed income market was up AGG +6.57%.
The last government relief package in the second quarter and the Federal Reserve efforts float the economy; it has paid off so far. The US economy and markets have reflected this government-initiated reflation effort. The rest of the developed markets and emerging markets have followed similar paths as well.
Although, the recovery of the economy is, so far, uneven and fragile at best. The markets have grown comfortable and accommodative with two concepts, not entirely proven facts but likely.
The first assumption, science will find a reliable solution or treatment to COVID-19 soon, and we will be back to normal as quickly as possible.
The second assumption, the US government will keep the economy going with further relief packages, low-interest-rate policies, and money printing by the Fed.
Both political parties seem eager to continue relief and support policies, so election results might not change this belief as much as people expect.
According to the current market narrative, one of the most significant economic changes to be aware of if there is a change in control of the White House and Senate might increase the corporate tax rate and estate tax exemption. But it is not guaranteed yet.
The financial markets psychology has stayed on course on these two beliefs. If for any reason, their odds diminish any day in the trading sessions, markets fall; if they improve, they rise. How, you may ask, by rumors and politicians twitter messages.
Of course, the markets care about the individual economy, industries, and companies' news and events, but the main levers above control the general market mindset so far.
As for the economy, the cornerstone is still stable. Household consumption had a remarkable recovery. The personal consumption had a drop of -18.5% in April 2020 from the February peak reading. As of August 2020, the index is just -3.4% below February 2020 peak. The recovery trend has slowed but still positive.
When we analyze the personal consumption of goods and services during 2020, we find that personal goods consumption is up +5.6% in August 2020 vs. February 2020 peak. But private consumption of services is still down -7.42%—a reasonable explanation of what we have evidence in these sectors' stock market. Still, the trend is positive in Q3 but slower than in Q2.
Moreover, the two drivers of consumers purchase power continue to improve, but at a slower pace in Q3:
- The US consumer sentiment is improving but still at 80.4 in September, compared to the 90 to 100 range before.
- September 2020, unemployment levels of 7.9%, had a quick recovery from April 2020 peak of 14.7%.
But it is still far from the below 4% mark we enjoy the last 24 months before COVID-19.
So it must be evident by now that the effects of the first relief package had a positive impact, but its power is wearing off. Therefore, the fixation of market participants on a new relief package.
Even the Federal Reserve has, on numerous occasions, stated that the risk of too much financial help to the economy is minimal. Still, the chances of not having it are plenty.
If we have a Q4 without an additional relief package, we might assess the economy's real status without aid, but I rather not have the experience If I had any choice.
The new market realities seem to be bound to a very low-interest-rate environment for several years and substantial budget deficits to finance government operations and relief packages.
Under these conditions, US market valuations remain sky-high, as investors overpay for growth potential and balance sheets quality. They are reluctant to let the value of their money dwindle in government bonds and cash.
This unreliable equilibrium of prices at their peak, and a broad set of other unprecedented conditions (locally and internationally) of this unique 2020, should make investors think about how much risk they are bearing.
At best, historically speaking, high-value markets mean returns going forward might be lower or less likely to occur. But as the US fiscal deficit will most likely continue, the currency might depreciate.
Under these scenarios, investors are pushed to the best alternative among the risks they faced. As there is no better alternative, equity risk is still king. Now geographical and sector diversification plays a key role, more than ever.
As in any new cycle beginning, risks are plenty, and so are the rewards for those who make the right choices. A new economic cycle has been born.
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