Looking at the stock market today, which is hitting record highs, you might think the pandemic is over. You might even question if a pandemic ever happened – until you go to the grocery store or try to buy Lysol wipes and remember this is far from over.
The disparity between the stock market and the external economic reality is a bit like motion sickness. Your brain is telling you one thing while your eyes see something else. Which are investors to believe: The rosy picture painted by stock prices, or the murkier one seen on the streets every day?
To get insight into what is going on, we spoke with Steven Skancke, chief economic advisor at wealth management and investment firm Keel Point. Skancke is a former economic staffer under the Nixon, Ford, Carter and Reagan administrations who also served on the White House National Security Council’s staff and economic policy team and in the U.S. Treasury. Read on to get his views on our current economic and financial situation, and where advisors should be looking during the recovery.
What should advisors be recommending in terms of asset allocation amid the current market?
The U.S. stock markets have a different perspective on the pandemic than do economists and public officials thinking about economic growth, consumer spending and getting people back to work. This involves the “here and now” of operating in a pandemic-focused environment. The stock markets are driven by what will come after the pandemic is vanquished and companies are finding a new normal, with corporate earnings rebounding from pent-up demand in consumer spending. The market figured out what was happening on or around March 23 and recovered most or all of its sell-off losses. Now, it is being driven largely by news about accelerated development of vaccines and massive, $10 trillion in fiscal and monetary stimulus. The current consensus, which is always subject to change, is that the U.S economy will end the year down between 5% and 6% and the S&P 500 likely will be up between 5% and 6%.
Investment portfolio asset allocation is built on a financial plan targeting investor goals and a solid understanding of investor risk parameters. The worry is always that after 11 years of a “bull market” in equities, investors’ propensity to accept and live through increased downside volatility has changed. For some, the market being down 34% in one month was a helpful reminder that downside risk may be different than they remembered. If so, this is a good time to reevaluate risk tolerance and rebalance portfolios.
Do you think we’re approaching bubble territory?
There are some aspects of the current market activity that feel like a bubble building. (The U.S. stock market rebounds along with record highs for the S&P and Nasdaq) seem incongruous with S&P 500 2020 earnings estimates, already forecast to be down between 20% and 25% for the year. Market investors, however, are looking to the time beyond the pandemic and seeing earnings estimates up 25% to 30% in 2021 and up in the mid-teens in 2022.
A bubble, however, is when stock prices are extrapolating an unrealistic earnings growth trend and not a bridge over a pandemic-created earnings abyss. However, the stock markets could quickly become a bubble bursting, and we can expect the market to trade vigorously up or down if hopes of near-term availability of effective vaccines and therapeutics exceed expectations or don’t materialize.
What market sectors do you think will lead or lag the recovery?
Figuring out the post-pandemic economic and business landscape is key to understanding what sectors will lead or lag the recovery. Currently, technology and other companies serving people working remotely in the pandemic environment have benefited the most. Personal and business transportation requirements are changing, and this likely will impact travel, transportation, lodging, hospitality and fossil fuel sectors negatively.
Similarly, personal consumption, which is 65% of the U.S. economy, is shifting from in-person retail spending to online shopping with shipping or curbside pickup, which will hurt retail and commercial real estate. We can expect that health care, automation, infrastructure and technology serving remote work environments will continue to be at the forefront of the recovery. Likewise, the recovery will be coincident with newly elected leaders taking office in the new year who, along with incumbents, are expressing a focus on electrification of transportation and other infrastructure investment.
What do the major economic indicators say about the economy currently and where it may be heading?
Economic indicators through mid-August are showing continuing improvement in economic activity, albeit at a slower pace than we experienced in May and June. New job creation in May and June provided big upside surprises, with July’s new jobs up 1.8 million and unemployment dropping to 10.2%.
Slowing economic recovery as a result of late June/July increases in COVID-19 infections and hospitalizations leading to reshuttering parts of the service economy in hard-hit states is turning around with new infections markedly down at the time of this writing. New consumer confidence metrics are due out this week. Fears that the slowing would become a drop back into recession are abating. Additional fiscal stimulus is needed but not likely until Congress returns to Washington after Labor Day.
How should the low mortgage rate environment be influencing advisors’ conversations with clients?
Low mortgage rates have been a welcome development as the demand for housing and homeownership has remained robust through the economic downturn. Consumer balance sheets continue to improve, as the stimulus checks and the $600 bonus unemployment benefit amounts have been used to pay down consumer debt and increase savings. Not all of this directly translates into new housing demand, but it creates opportunities for continued and increasing housing demand as the economy emerges from the pandemic burden. For families with existing, higher-rate mortgages, this is a good time to refinance. Especially given the historically low rates, with the 30-year fixed-rate mortgage now less than 3%.
What is the most important trend driving the financial industry today?
The most important trend influencing the financial services and wealth management industries today is new, lower-for-longer interest rates on fixed-income investments and helping clients adapt their portfolios and goals appropriately. With increased volatility in equity markets, the tendency to think of reducing risks in portfolios is understandable but unhelpful in achieving long-term, carefully planned goals. Understanding and rebalancing client risk/reward profiles are critical to enabling client success in meeting financial expectations. Twenty-five years ago, a lower-risk bond portfolio could generate 7% annualized returns, but not today or in the foreseeable future.