This year has seen a global pandemic that led to government-mandated economic shutdowns, the subsequent fastest bear market in U.S. history, the fastest market recovery in U.S. history, and the ensuing highest stock market in U.S. history—not to mention social unrest in the form of protests, riots, and even occupied areas. The race for a COVID-19 vaccine continues, and the first U.S. vaccines are expected by November, while the bulk of vaccines are estimated to be available months later. Amid this global recessionary environment, a highly divisive U.S. presidential election is taking place in November.

What Happened Last Quarter:

The U.S. bond and stock markets rebounded in spectacular fashion in the second quarter, spurred by unprecedented Federal Reserve actions, government stimulus packages, and a societal desire to return to a strong economy following government-mandated shutdowns. States, locales, and consumers across the country adjusted to COVID-19 restrictions while economic “green shoots” began to appear. Business activity reported expansionary numbers, unemployment began to fall, and retail demand outpaced industrial supply. Third-quarter GDP growth is currently estimated at around 24%, a huge reversal from the second quarter. The official GDP growth estimate for the second quarter of 2020, as reported by the Bureau of Economic Analysis, was a shocking contraction of 31.4%. 

What We Think It Means:

It is important to understand that the stock and bond markets are not the economy—they are only parts of the economy. The stock market is considered a “leading indicator,” meaning it takes action before the rest of the economy. This leading action happens in both positive and negative environments. As we saw earlier this year, the stock market declined before the rest of the economy shut down. The stock market recently has been flirting with new all-time highs as the broader economy continues to claw its way out of a recession. Unemployment, a lagging indicator, follows the broader economy and by nature will lag behind the stock market. Knowing this dynamic of leading and lagging indicators is important because market participants look to the future when making investment decisions. Thus, our behavior as investors is vital to our investment success. Coupling this knowledge of leading/lagging indicators with the understanding that markets can be volatile at times, we can keep a long-term perspective, which becomes a valuable means to deal with the market’s ups and downs.

While the -31.4% GDP growth figure from the second quarter certainly is shocking, it was better than expected, as the consensus estimate was around -35%. The expected GDP for the third quarter is +23.9%, according to The Wall Street Journal’s latest survey of economists, signaling that the U.S. is likely past the worst of the recession. Because the Federal Reserve and Congress have injected massive liquidity into the economy and because COVID-19 restrictions continue to be lifted, economic progress is likely to continue in the near term. But that doesn’t mean that the recession is over. Retail demand has outpaced industrial supply, and this has had a positive impact. But we feel that this outcome is somewhat artificial because of the massive fiscal and monetary stimulus provided by the U.S. government. The Federal Reserve announced a change to its inflation policy and will allow inflation to run higher than its traditional 2% target. In addition, the Fed likely will not raise interest rates in 2021 and possibly not until 2023. This posture from the Federal Reserve paints a picture of lower bond yields for longer, making stocks relatively more attractive.

Over the long term, we see an interest rate environment that is favorable for stocks. In the near term, we expect spikes in volatility caused by uncertainty about the timeline for the development and distribution of a COVID-19 vaccine, over-valuation in some stocks, and the looming presidential election. If there is one thing the stock market doesn’t like, it is uncertainty. Once we are past the election, uncertainty should begin to dissipate.

Until next quarter,

-Investment Committee