To say that 2020 has been an unusual year would be an understatement. Never before have governments been forced to shut down their economies to stop the spread of a deadly virus. The stock market responded to the shutdown as would be expected with the S&P 500 declining 34% from February 18th to March 23rd.
Governments then implemented massive fiscal stimuli and monetary policies to support their economies through the shutdown and restart. Though uneven, the economy is recovering, and additional fiscal stimulus will likely still be needed in the United States until a vaccine is widely available.
After the rocky start to the year, stocks have largely recovered from their first quarter selloff. The S&P 500 gained 35% from the March 23 low through the end of the second quarter. The index then gained another 9% in the 3rd quarter and this index is now actually up nearly 6% for the year.
The reported year to date gain of the S&P 500 of 6% is a bit misleading, however. The S&P 500 index is a market capitalization weighted index – six companies (Facebook, Apple, Amazon, Netflix, Google / Alphabet and Microsoft) which make up slightly more than 25% of the index were up 38%. The S&P 500 excluding these six stocks was down over 4% through the first three quarters and the Russell 2000 (broad market index) was down nearly 9%.
Corporate profits are expected to decline 20% this year but are projected to return to 2019 levels next year. In 2021, S&P 500 earnings are expected to be $165. The S&P 500 was 3,363 on September 30th so this index was trading at 20.4 times forward earnings. This level is above the 10-year average forward earnings multiple of 15.4 but still below the peak tech bubble valuations of 25.
While I would not argue that stocks are cheap, valuations do look more reasonable when you factor in interest rates – the yield on the 10-year Treasury Bond was 6.5% at the end of 2000, the yield at the most recent quarter end was less than 0.7%.
The Presidential elections are around the corner. There has been a great deal of concern that a sweep by the Democrats would bring an increase in corporate and individual taxes which might negatively impact the economy and the stock market. It is also possible that a sweep by the Democrats might bring an increase in government spending which could act as an offset to higher taxes. A challenged election result would not be a positive outcome and would likely not be well received by the stock market, but the impact should not be long lasting.
Vaccines for the COVID virus will bring great relief. We all crave a return to life as we knew it. I anticipate that we will have vaccines in the coming months and that they we be widely available by mid-year 2021. If this occurs, then the economy will continue to recover, and the investment backdrop will continue to improve.