August 11 2020 Market Update
Markets Climb Higher Amid Economic Dislocation
Domestic stocks continued to charge higher in July, despite record low economic output and an uncertain outlook. The S&P 500 shrugged off regional surges in coronavirus cases to rise 5.5 percent for the month, its best July since 2010.
That said, the Commerce Department’s initial estimate of second quarter GDP showed that U.S. economic activity plunged 32.9 percent, marking the worst GDP contraction on record. However, investors chose to look ahead, and better-than-expected early company earnings reports also lifted market sentiment.
In light of this, many investors are asking: how healthy is the economy and what lies ahead in the coming months?
The economy this summer
Given that two-thirds of US economic output is driven by consumer spending, the resilience of consumer spending will likely be a significant factor in the speed of a recovery.
Consumer spending rose 5.6 percent in June. This followed May’s record increase of 8.5 percent. Although the spending rebound bodes well for third quarter consumption, declining personal income amid the expiration or reduction of extended unemployment benefits is a key concern for market observers. Depending on the passage of additional support for unemployed workers and the impact of COVID-19 on local economies, we could see a reversal in consumer spending over the coming months.
Meanwhile, there have been signs that the manufacturing sector may be on more solid footing. The Institute for Supply Management’s July Manufacturing Purchasing Manager’s Index, a gauge of manufacturing activity, was 54.2, the second straight month of expansion. Similarly, the July Purchasing Manager’s Index for services, at 58.1, was also encouraging. A reading above 50 implies an expansion in activity, while readings below 50 indicate a contraction.
At the surface, these figures appear strong, but investors should also take note of the ISM Employment Index, which slipped 1 percent in July, to 42.1. This was the fifth straight month the index sat in contraction territory.
Despite encouraging signals elsewhere, this may imply that there is trouble ahead given the importance of employment on personal income and consumer spending.
Implications for investors
So, how do we reconcile the dislocation between U.S. economic output and the continued rise in the markets?
We have covered this in detail before, but at its simplest, one could argue that the market has glazed over the disconnect between a recessionary second quarter and surging stock prices because investors see a light at the end of the tunnel. Many investors have high hopes for a “V” shaped recovery in the second half of the year and early 2021.
However, that optimism could fade if we see continued negative developments in the spread of COVID-19, as we did in July, or if economic output doesn’t rebound as quickly as expected. Ongoing fiscal and monetary stimulus will be instrumental in helping us cross the bridge over the abyss. Any glitches could send us rapidly falling backwards.
The rise in equities has been comforting to many investors, but the truth is we remain in a highly uncertain economic environment. While markets have been good to investors despite the economic and health issues facing the US, it’s important to remember that these are unprecedented times. We cannot stress enough the importance of a prudent, diversified, and diligently managed investment strategy.
It’s also important to note that this rally has not been broad-based. Economically sensitive sectors like energy and financials have lagged badly, while companies benefiting from the “stay-at-home” theme have thrived. Trends in online shopping and remote workforce deployment have propelled technology-related companies to fresh all-time highs.
For example, at the end of July, the technology sector comprised 27.5 percent of the S&P 500 index. This is more than the weighting of the smallest six sectors combined. The top five constituents by weight are all technology stocks (Apple, Microsoft, Amazon, Facebook, and Alphabet) and have grown to represent over 20 percent of the entire index.
As technology is one of the most volatile sectors, we believe the index itself could become more susceptible to volatility – and in some cases less-aligned with an individual’s goals. Of course, the COVID-19 situation remains fluid and we will continue to monitor developments as they impact the economy and capital markets.
We encourage you to reach out to us with any questions, comments, concerns, or just to check in. Wishing you a safe and healthy end of summer.
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: https://eresearch.fidelity.com/eresearch/markets_sectors/sectors/si_weighting_recommendations.jhtml?tab=sirecommendations and https://www.wsj.com/articles/techs-stock-market-takeover-reaches-new-heights-11596985224