Home Business Stocks Generate Big Gains and Bigger Questions

Stocks Generate Big Gains and Bigger Questions


Consider this opportunity: You can invest in a stock market that is greatly overvalued now but that could be only slightly overvalued next year if a lot of good things happen — during a time when a lot of bad things are happening.

Are you in?

This isn’t a thought experiment. It’s more or less the deal available to anyone buying stocks today, in the view of many analysts and fund managers. Judging from the market’s performance, it’s one that a lot of investors are taking.

The S&P 500 rose 20 percent in the second quarter. With the pandemic far from over. With earnings sinking. With public debt expanding. With unemployment at multidecade highs and much of the economy still barely able to get up off the deck.

A bounce in economic indicators and stocks was expected at some point, given how far both fell after the pandemic took hold. But skeptics warn that further progress on either score may be much harder to achieve.

“We’ve gotten the gains, now we’ve gone too far,” said Tobias Levkovich, chief United States equity strategist at Citi Research. “What happens to the tens of millions of unemployed? Retailers are closing stores. Where do those jobs go?”

Such questions may not be answered until after the November election, when the course of government policy should become clearer, Mr. Levkovich said. Until then, banks may be reluctant to lend and companies may be reluctant to hire.

“There’s still a fair amount of uncertainty, including the elections, including how we exit the pandemic,” he said.

Saira Malik, head of equities at Nuveen, agreed that “there’s a disconnect between the stock market and the economy.”

The good market news could prove fleeting, she said, if the latest spikes in infections produce significant increases in hospitalizations and deaths, and if consumers are less inclined to spend if they’re still out of work and new government stimulus payments aren’t forthcoming.

But widespread faith in the Federal Reserve has bolstered the markets. The Fed announced its intervention in March, through easy monetary policy and the purchase of financial assets with money created out of thin air. Many strategists applaud the Fed’s short-term moves but are troubled by the long-term implications.

“I’m not sure they could have done anything else in this scenario,” Steve Kane, a bond fund manager at TCW, said. The Fed has signaled that short-term interest rates will remain close to zero for at least two years and promised to buy a virtually unlimited supply of debt instruments, from Treasury bonds to exchange-traded high-yield bond funds.

The Fed may have been forced to try to prop up the economy, and succeeded for now, but Mr. Kane warned that “there’s likely going to be a cost” for these actions.

“By not allowing the private economy to price risk appropriately, they’re going to keep zombie companies alive,” he said. “That will result in a less efficient economy and lower growth. Another thing that could happen is inflation could come out the other side if you have high structural unemployment and the government keeps spending.”

Another source of bullish sentiment is a willingness to ignore the severe downturn and look “across the valley,” as a newly popular phrase has it, evaluating investment prospects based on forecasts for a rosier post-pandemic environment.

The S&P 500 traded at the end of June at 24.4 times what analysts expect the companies in the index to earn this year, according to FactSet Research, compared with the average valuation of 18.8 times earnings over the last two decades. Using the forecast for 2021, which calls for a nearly 30 percent increase in earnings, the index traded at 19 times earnings.

That 2021 valuation would be barely more expensive than the two-decade average, but a forecast is just that. Earnings indeed may bounce back sharply from today’s levels, which have been depressed by the mandated shutdown of much of the economy, but there is no guarantee that they will.

Whatever valuations may be in the longish-term future, they sure look high now, and they never got all that low during the first-quarter sell-off.

“Valuations were higher at the March 2020 bottom than any other bear market bottom of the past 55 years, regardless of the measure,” James Stack, editor of the InvesTech Research investment newsletter, wrote in a recent issue. “Not only that, but the subsequent rebound in the market has further exacerbated the existing valuation problems.”

If the stock market is forming a bubble, it expanded mightily in the second quarter, to the benefit of fund owners. The average domestic stock fund rose an astounding 21.7 percent, according to Morningstar, led by portfolios focused on industrials, consumer cyclicals, natural resources and especially technology.

Holders of international stock funds had to make do with an average gain of 19.7 percent. Latin America and Asia specialists did the best.

Those performances contributed to the overvaluation that some analysts are warning about. Adding to the risk is the possibility that the valley in economic growth and earnings that bulls are looking across may be far wider than expected.

Economists at the U.C.L.A. Anderson School of Management stated in a report that the pandemic had “morphed into a Depression-like crisis.” They estimate that the economy declined at a 42 percent annual rate in the second quarter and predict that the lost ground will not be made up until 2023.

It’s not just stock investors that are ignoring such warnings. The average bond fund rose 6.5 percent in the quarter, propelled mainly by those that specialize in the riskiest issues. High-yield funds rose 9.4 percent, and the ones that own emerging market debt were up 13 percent. Long-term government funds were flat.

  • Updated July 7, 2020

    • What are the symptoms of coronavirus?

      Common symptoms include fever, a dry cough, fatigue and difficulty breathing or shortness of breath. Some of these symptoms overlap with those of the flu, making detection difficult, but runny noses and stuffy sinuses are less common. The C.D.C. has also added chills, muscle pain, sore throat, headache and a new loss of the sense of taste or smell as symptoms to look out for. Most people fall ill five to seven days after exposure, but symptoms may appear in as few as two days or as many as 14 days.

    • Is it harder to exercise while wearing a mask?

      A commentary published this month on the website of the British Journal of Sports Medicine points out that covering your face during exercise “comes with issues of potential breathing restriction and discomfort” and requires “balancing benefits versus possible adverse events.” Masks do alter exercise, says Cedric X. Bryant, the president and chief science officer of the American Council on Exercise, a nonprofit organization that funds exercise research and certifies fitness professionals. “In my personal experience,” he says, “heart rates are higher at the same relative intensity when you wear a mask.” Some people also could experience lightheadedness during familiar workouts while masked, says Len Kravitz, a professor of exercise science at the University of New Mexico.

    • I’ve heard about a treatment called dexamethasone. Does it work?

      The steroid, dexamethasone, is the first treatment shown to reduce mortality in severely ill patients, according to scientists in Britain. The drug appears to reduce inflammation caused by the immune system, protecting the tissues. In the study, dexamethasone reduced deaths of patients on ventilators by one-third, and deaths of patients on oxygen by one-fifth.

    • What is pandemic paid leave?

      The coronavirus emergency relief package gives many American workers paid leave if they need to take time off because of the virus. It gives qualified workers two weeks of paid sick leave if they are ill, quarantined or seeking diagnosis or preventive care for coronavirus, or if they are caring for sick family members. It gives 12 weeks of paid leave to people caring for children whose schools are closed or whose child care provider is unavailable because of the coronavirus. It is the first time the United States has had widespread federally mandated paid leave, and includes people who don’t typically get such benefits, like part-time and gig economy workers. But the measure excludes at least half of private-sector workers, including those at the country’s largest employers, and gives small employers significant leeway to deny leave.

    • Does asymptomatic transmission of Covid-19 happen?

      So far, the evidence seems to show it does. A widely cited paper published in April suggests that people are most infectious about two days before the onset of coronavirus symptoms and estimated that 44 percent of new infections were a result of transmission from people who were not yet showing symptoms. Recently, a top expert at the World Health Organization stated that transmission of the coronavirus by people who did not have symptoms was “very rare,” but she later walked back that statement.

    • What’s the risk of catching coronavirus from a surface?

      Touching contaminated objects and then infecting ourselves with the germs is not typically how the virus spreads. But it can happen. A number of studies of flu, rhinovirus, coronavirus and other microbes have shown that respiratory illnesses, including the new coronavirus, can spread by touching contaminated surfaces, particularly in places like day care centers, offices and hospitals. But a long chain of events has to happen for the disease to spread that way. The best way to protect yourself from coronavirus — whether it’s surface transmission or close human contact — is still social distancing, washing your hands, not touching your face and wearing masks.

    • How does blood type influence coronavirus?

      A study by European scientists is the first to document a strong statistical link between genetic variations and Covid-19, the illness caused by the coronavirus. Having Type A blood was linked to a 50 percent increase in the likelihood that a patient would need to get oxygen or to go on a ventilator, according to the new study.

    • How can I protect myself while flying?

      If air travel is unavoidable, there are some steps you can take to protect yourself. Most important: Wash your hands often, and stop touching your face. If possible, choose a window seat. A study from Emory University found that during flu season, the safest place to sit on a plane is by a window, as people sitting in window seats had less contact with potentially sick people. Disinfect hard surfaces. When you get to your seat and your hands are clean, use disinfecting wipes to clean the hard surfaces at your seat like the head and arm rest, the seatbelt buckle, the remote, screen, seat back pocket and the tray table. If the seat is hard and nonporous or leather or pleather, you can wipe that down, too. (Using wipes on upholstered seats could lead to a wet seat and spreading of germs rather than killing them.)

    • What should I do if I feel sick?

      If you’ve been exposed to the coronavirus or think you have, and have a fever or symptoms like a cough or difficulty breathing, call a doctor. They should give you advice on whether you should be tested, how to get tested, and how to seek medical treatment without potentially infecting or exposing others.

Although holders of safer government issues haven’t had much to show for it lately, Mr. Kane figures that the outlook is better for them.

“You’re not getting paid to take that risk” in high-yield debt, he said. Treasury instruments, though, will benefit “if the Fed is going to do what the market anticipates, which is nothing on rates for a long time and in the near term support the market” with bond purchases.

But the near term won’t last forever. After economic and commercial life get somewhat back to normal, the pandemic and the steps taken to mitigate its impact may be felt for years, maybe decades. The Fed’s extraordinary actions are not the only potential source of trouble originating in Washington.

“We’ve seen a divided Congress with an unconventional president enact fiscal stimulus on a scale that is creating budget deficits that were inconceivable to prior administrations,” said Chris Brightman, chief investment officer of Research Affiliates.

What’s more, he fears that the extraordinary levels of government stimulus and intervention in the economy during this crisis may come to be expected, especially by younger generations. “We’re going to see trillion-dollar deficits for years,” he said.

All that could mean higher taxes and consumer prices, and much lower corporate profits for years to come, he said. And with American stocks already carrying valuations higher than markets elsewhere, there “is a potential opportunity for those who want to limit equity investment in the U.S.” and invest more abroad, he said.

Ms. Malik at Nuveen favors foreign and domestic stocks alike, but only those of high-quality businesses.

“Companies with strong free cash flow and resilient balance sheets will continue to outperform,” she predicted.

Her recommendations include economically sensitive Japanese companies, the American technology industry, companies that grow slowly and steadily and continually raise their dividends, and businesses worldwide that rank high on environmental, social and governance criteria.

She also would take a chance on higher-quality stocks in emerging economies that were performing well before the pandemic, such as in Brazil. Finding such stocks is difficult for ordinary investors, so she suggests doing it through actively managed specialist funds with good track records.

Mr. Levkovich at Citi Research would focus on market segments that would benefit from modest, but not spectacular, economic growth. He foresees banks, health care, semiconductors and tech hardware doing well, but he would limit exposure to industries like energy that are more economically sensitive and have performed especially well, maybe too well, lately.

Mr. Kane likes banks, too. Their financial strength, as they continue to heal from the self-inflicted injuries of the financial crisis, makes their bonds suitable assets to own, along with those in safer areas like consumer staples.

He expects that high quality to come in handy as companies find they need all the help they can get as the virus and recession run their courses, even if you wouldn’t know it from how the stock market has been acting.

“Certain businesses just are not going to have the opportunity to get back to where they were,” he said. “Unemployment is going to remain elevated. That will affect business behavior, consumption, savings. The economy will disappoint the optimistic assumptions largely built into asset prices.”

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