Few things about 2020 have felt normal, and the November election is not likely to offer much relief. But as we have learned time and again throughout history – and in particular this year – stocks love to climb a wall of worry. Even though U.S. stocks posted their weakest September in almost 10 years, the S&P 500 index still managed to finish the third quarter up +8.5%. Together with Q2, the S&P 500 has risen by almost +30% in six months, delivering its best two-quarter performance since 2009. Defying just about everyone’s expectations, U.S. stocks are positive in 2020.1
One of the biggest economic stories of the quarter came from the housing sector. In the month of July, housing sales soared 23% from June, hitting an annual pace of close to 1.5 million. Sales of new single-family homes jumped 14% month-over-month in July, hitting an annual pace of 901,000. For the first time ever, the median price of an American home is greater than $300,000.2 The strength we’re seeing in the housing market today is roughly equal to what we saw 2005, when the housing market peaked.
Downstream effects of the housing boom have been evident in consumer spending on furniture, appliances, and home improvement, which has outperformed spending across most other sectors. Construction employment has recovered briskly. One familiar name in the space, Home Depot, offers anecdotal evidence of the sector’s strength: the company posted its best quarterly (Q2) sales growth in nearly 20 years.
While housing enjoys a strong year, the jobs market is rebounding but also struggling to claw its way back to pre-pandemic levels. In September, U.S. employers added 661,000 jobs, which was far below the 859,000 expected and marks a sharp slowdown from gains made over the summer. The U.S. has replaced 11.4 million of the 22 million jobs lost to the pandemic, but momentum is likely to slow until the virus comes under better control and/or a vaccine is widely distributed. Neither outcome seems likely for 2020, which underscores the need for more fiscal stimulus before the end of the year, in my view.
In late August, Federal Reserve Chairman Jerome Powell laid out a new policy vision for the Fed, indicating they would be implementing a “flexible form of average inflation targeting.” This was Fed-speak for saying the Fed will allow inflation to drift above 2%, meaning they appear increasingly willing to let inflation overshoot its targets in an effort to push unemployment back to its maximum level. 17 Fed officials said they believed rates would stay near zero until at least the end of 2021, with 13 officials pushing the date further out to 2023.3 For investors, the Federal Reserve essentially codified ‘lower for longer’ interest rates in the third quarter.
Finally, I think there have also been underappreciated, pandemic-related positives supporting markets. In particular, the lower incidence of Covid-19 deaths in Q3 may help explain the relatively muted market response to rising infections. Over time, we have also gained a better understanding of the virus, which likely allowed risk assets to anticipate the quicker-than-expected restart. The U.S. health system is also much more prepared for hospitalizations today than it was three or six months ago.
What to Expect Ahead
I’ll start with earnings. We expect total S&P 500 earnings to decline -22.8% from the same period (Q3) last year, on -2.9% lower revenues. This earnings decline seems steep, especially following the -32.3% decline in Q2 when economic and business activities came to a halt as a result of the pandemic-driven lockdowns.4 But investors should focus less on the earnings decline and more on how earnings expectations have changed over time.
In that light, the earnings outlook has been steadily improving since the start of Q3 (see the chart below). While the latest labor market and factory sector readings suggest some deceleration in the recovery, we believe the economy will power-through and support a sustained improvement to the earnings trend. In my view, if earnings are even just marginally better than what most expect, the stock market should feel the tailwind.
Perhaps the trillion-dollar Q4 question is whether Congress and the White House will ink a deal for more spending. I personally think we will see more fiscal stimulus in the next three to six months – which will be a boost for equity markets – but this outcome is far from assured. Most everyone on Capitol Hill (and at the Federal Reserve for that matter) agrees that more stimulus is needed, but coming to terms on how much and where to spend has been elusive thus far. Look for an unexpected breakthrough in Q4.
Bottom Line for Investors
“Uncertainty” seems to be the word du jour for describing the United States’ economic, political, and social situations. The economy has made strong gains off the bottom of the recession, but remains a long way off from pre-pandemic activity. Some of the gains from the summer were the low hanging fruits of economic recovery, and I think more stimulus is needed to bridge the country to the vaccine. From what I can see today, the economy is not poised to go in reverse in Q4, but the tailwinds are fading.
Even still, the markets almost always move on expectations vs. reality, and if the economy and corporate earnings – and the election, for that matter – all post results even just marginally better-than-expected, stocks should do just fine in the next six months.