By Lisa Beilfuss
Floor traders returned to the New York Stock Exchange in May after the coronavirus forced a rare shutdown of physical trading operations. / Brendan McDermid/Reuters
The U.S. economy added a more-than-expected 4.8 million jobs in June. Yet nearly 20 million Americans remain out of work.
The June jobs report brings to a close the first half of 2020 with the same dissonant note that has been so familiar during this extraordinary year. The coronavirus pandemic, which has sickened 2.6 million Americans and killed over 128,000, brought swaths of the U.S. economy to a virtual halt and threw it into recession, knocking the S&P 500 down 34% into a bear market.
The stock market then called the recovery before the economic data started to corroborate it, with the S&P 500 re-entering a bull market and now within striking distance of pre-virus prices.
Still, the economy is far from normal and will take a long time to absorb the millions of unemployed workers who will hold down consumer spending, threaten corporate profits, and weigh on strained state and local budgets. What’s more, the viral threat remains, casting a cloud over the economy and markets.
The conversation over recent months, at least as far as economics and markets go, has been dominated by a debate over the shape of the recovery. There is the V-camp, the U-camp, and the W-camp. Some have gotten more creative, calling for something resembling a Nikeswoosh or a reverse square root sign (√, in reverse).
We began the second half of 2020 with hope building that the recovery will resemble a V, as lockdowns in many parts of the country were relaxed sooner than predicted and consumers have shown a willingness to return to normalcy despite the pandemic.
But these improvements have come at a cost. Covid-19 cases are surging, prompting companies and states to reverse or delay reopenings and giving consumers a renewed sense of caution. The pandemic’s course and the responses to it will determine what happens to the U.S. economy over the back half of the year and beyond.
While hiring in May and June showed momentum in a recovery from the worst of the pandemic lockdown, says David Kelly, chief global strategist at J.P. Morgan Asset Management, “investors should recognize that we are still very far from a healthy job market and that a recent resurgence in the pandemic will make further progress slower.”
To try to piece together a second-half outlook for the U.S. economy and stock market, Barron’s looked to a half-dozen strategists. Here’s what they say.
Bear Case
Against a backdrop of slower progress, it’s easy to get bearish. While economic data over the past month have mostly surprised to the upside, suggesting the recovery began earlier and has been more robust than anticipated, data are lagging. Already even the June jobs data are stale given the resurgence in coronavirus cases and reopening rollbacks.
Over the past week, Arizona, California, Georgia, and Texas all reported a record number of daily Covid-19 infections. California is closing bars and indoor dining again in many of its counties, and New York City said it would delay its reopening of indoor dining.
On top of the uncertainty around the virus—the continuation of the first wave, the magnitude of a second that many believe will come this fall, and the timing and efficacy of a vaccine—is a laundry list of other interconnected unknowns. Will schools and day-care centers open in the fall, or will working parents continue to lack child care?
Will Congress extend the enhanced unemployment benefits, set to expire July 31, that have helped plug the hole in household income and spending? Will state and local governments receive adequate aid to fill budget gaps given the loss of tax revenue? And of course there is the presidential election in November.
The unusual degree of uncertainty confronting consumers and investors may constrain economic activity for the rest of the year and keep a lid on the stock market, says Brian Singer, head of dynamic allocation strategies at William Blair.
“My outlook isn’t disastrous, but I’m not terribly optimistic, either,” Singer says, adding that we’ve probably seen stock-market highs for the year. He says much of the trouble in the economy isn’t so obvious, given that small businesses hit hardest by the pandemic aren’t publicly traded, meaning much of what’s driving the economy isn’t driving the market.
Daily data from Opportunity Insights, part of Harvard University, show small-business revenue hasn’t much improved since reopenings began in earnest, while the number of small companies open are down 16% from January. At this point, it’s fair to assume a chunk of businesses not open have closed permanently.
Strategists say a bear case would feature a delay in a widely available Covid-19 vaccine until 2022 and strict, coordinated lockdowns to stem coronavirus cases that pick up this fall. A much deeper economic contraction and potentially another stock market correction would follow.
Under its bear-case scenario, Morgan Stanley has minus 10.2% penciled in for its 2020 gross-domestic-product forecast. Oxford Economics has minus 17.2% for its bearish projection. Meanwhile, Michael Kantrowitz, chief investment strategist at Cornerstone Macro, predicts a 20% decline from current levels in the S&P 500 in his bear case.
That would translate to roughly 2500 and make stocks in the defense, utilities, and consumer-staples sectors more attractive while consumer discretionary and industrial stocks would become unattractive, he says. Katerina Simonetti, a senior portfolio manager at UBS private wealth management, estimates 2800 for the S&P 500 by year-end should everything go wrong.
Base Case
We’re not inclined to get too pessimistic just yet. The strategists Barron’s interviewed aren’t counting on a bear-case scenario, either. Kantrowitz, for example, puts 50% odds on his base case and splits the rest between his bull and bear cases.
Base-case scenarios across Wall Street share a few assumptions. First, the coronavirus is something Americans will have to live with for an extended period. Second, the Federal Reserve will continue to do whatever it takes to support the economy and financial markets. And third, Congress will pass additional aid to households and businesses to the tune of at least $1 trillion.
Under her baseline scenario, Simonetti sees a gradual lifting of lockdown restrictions coupled with the existence of a vaccine or therapy by fall, and the mass production of a treatment by mid-2021. Together, that would lead to a sustainable economic recovery by the third quarter of this year and a return to normal activity by the end of the first half of next year. She in turn expects S&P 500 earnings to improve by the end of 2020, adding up to a target for the index of 3300.
The most likely picture includes a stock market that chops sideways from here as social distancing remains strict and reopenings stop and start, Kantrowitz says. Unemployment will remain in the double digits through December, and economic data will look less impressive as the virus lingers and bursts in activity from April’s bottoms fade.
“We’re still in irrational exuberance territory for equities,” he says, adding that the S&P 500 trading at such an expensive multiple against this backdrop makes stock-picking more important after a long boom in passive index investing. The forward price/earnings ratio for the S&P 500 is at 22.1, not far off its peak in 2000.
The Number of Covid-19 Cases Is Rising. What Comes Next.
He’s not alone. Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, predicts the S&P 500 trades between 2900 and 3200 for the rest of the year and is telling clients the index is expensive, crowded, and increasingly concentrated in a small handful of tech names.
“We’re just not interested in owning the S&P 500,” Shalett says. That’s despite Morgan Stanley’s conviction in a deep V-shaped recovery over the next four to six quarters. The market anticipated a lot of the good news we’ve gotten, and now corporate earnings need to catch up, she says, encouraging stock-picking in areas leveraged to the economy.
Instead of owning the S&P 500, Shalett favors financial, materials and energy stocks because they’re cheaper than the broader market while leveraged to the economic recovery and correlated with rising inflation. (Strategists agree inflation will remain at bay over at least the next two quarters—some say much longer—before beginning to bubble.)
Kantrowitz, meanwhile, prefers industrial and consumer discretionary stocks under his baseline scenario for the second half and is betting growth will continue to outperform value, while Simonetti likes mid-caps across telecom, health care, and food.
Bull Case
While we’re not overly pessimistic, it might be a good time for bulls to rein in their optimism. Their case for the economy and stock market assumes the worst is behind us. Rising Covid-19 case numbers in states that reopened early and subsequent reopening rethinks are casting doubt that a bull scenario can be achieved.
To get there, strategists say it would take a vaccine that is widely available before the end of 2020—as opposed to mid-2021—coupled with a second wave of infections in the fall that is much smaller than the first.
Simonetti says her bullish scenario, which she considers unlikely, includes an S&P 500 target of 3500. “In our upside scenario, everything is going right,” she says, leading to a return to “absolutely normal” activity by the fourth quarter of this year. Even then, she expects unemployment to remain above 10%, despite ongoing stimulus efforts and improving corporate earnings that would be part of such a scenario.
Data from Appleshow mobility across the country has improved significantly since April, the only full month of nationwide lockdowns, mostly thanks to increased driving that is offsetting declines in walking and the use of public transportation.
Strategists at Morgan Stanley say their bull case includes faster reopenings and greater mobility, which would lead to a normalization of economic activity. If all that were to happen, they say U.S. GDP would be down 2.1% for 2020.
The Catch-22 is that achieving such a scenario relies on a robust recovery that itself risks more infections and renewed shutdowns. On this front, Cornerstone’s Kantrowitz says two numbers he’s watching are raising red flags. The rising positivity rate, or the percentage of people testing positive, is leading to higher hospital occupancy rates that could trigger more shutdowns, he says. Given how much of the increasingly tenuous recovery the market has priced in since March lows, Kantrowitz doesn’t see the S&P 500 above 3400 even under his best-case scenario.
There is more to the idea that there’s a bearish lining in a bullish scenario. Peter Boockvar, chief investment officer at Bleakley Advisory Group, says that if there’s a vaccine by October, the stock market will love it. But the bond market won’t, potentially triggering a rise in global interest rates that would make relatively high stock market valuations harder to justify and ballooning corporate, household, and government debt balances more problematic.
A vaccine that arrives sooner than later will help bring back demand, but it would also bring forward inflation pressures, he says, effectively transforming a bullish outcome into a bearish one.
“We’re going to get through this, but how many jobs will come back, how many businesses will reopen, how long before we get back to [pre-virus] GDP and earnings per share?” Boockvar asks. “The market has had a hall pass, looking past bad data and focusing on the reopening.”
He added that investors have to consider changes in consumer behavior and the possibility that companies will try to do more with less.
Whether the U.S. economy takes off from here or stumbles through the end of the year, there is one thing strategists agree on: The S&P 500 is likely to trade in a pretty tight range for the rest of 2020.
It’s from there that things will get more interesting, as the unknowns piling up reveal themselves.
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