U.S. equity investors buckle up as markets take them for a ride

Brian Nick

The last week’s market highlights:


Quote of the week:

“Fear is a reaction. Courage is a decision.” — Winston Churchill

Can momentum regain momentum?

Many equity investors follow a simple strategy: keep buying the stocks that have been performing the best (often referred to as the “momentum” trade). For more than a decade, the stocks performing the best have tended to be those of high-growth companies, including technology bellwethers Facebook, Apple, Amazon and Alphabet (parent of Google), which represent four of the five largest constituents of the U.S. equity market.
Growth stocks typically benefit from a “Goldilocks” economy in which the outlook is neither too hot (which typically favors economically sensitive cyclical shares) nor too cold (aiding defensive sectors) and the interest-rate environment is “lower for longer.” These are precisely the conditions that have prevailed over the past several months, reflecting the U.S. economy’s continued recovery from the pandemic-driven recession and the Fed’s ultra-dovish monetary policies and forward guidance. Against this backdrop, the growth/momentum/technology trade has done very well.
Indeed, for the year to date through September 2, the technology-dominated Nasdaq 100 Index was up 42%, outperforming the broad-market S&P 500 (+11%).3  But the Nasdaq 100 slumped 11% over the next three trading days, with no specific market catalyst.4 Headlines pounced: Has the momentum trade lost its momentum?
Probably not.
In our view, the recent swing away from growth and toward defensive stocks is unlikely to persist in a growing economy highlighted by companies with rising earnings. At the same time, given September’s 12% drop in oil prices so far, along with a flatter U.S. Treasury yield curve — two indicators of market pessimism about economic growth — it’s hard to argue that a lasting rotation into cyclical and value names is the likeliest scenario.5
Individual investors are certainly not bullish. On the contrary, they’ve been bearish for 29 consecutive weeks, according to a leading sentiment survey.6 And they’ve pulled money out of equity funds for 20 straight weeks, to the tune of $266 billion.7 It’s possible that a November win by Donald Trump, considered in some polls to be a better steward of the economy than Democratic hopeful Joe Biden, could trigger inflows, just as his surprise 2016 win did. That scenario, were it to occur, might boost cyclical sectors like financials and industrials, leaving technology a relative underperformer — at least for a while. At some point, as the economy settles back into the “old new normal” (2% GDP growth and low inflation), the case for high-growth stocks could again become compelling.

Will the U.S. economy be able to jump over the fiscal hole?

It’s been clear to us that the lapse of several CARES Act provisions in August and September will leave the economy in a bit of a hole. Enhanced unemployment benefits have just started to come back online in most states, due to President Trump’s executive orders, but that money ($300/week) is only half the amount paid under the original provision, and it will run out in just over a month as nearly 30 million Americans continue to collect. Meanwhile, the Paycheck Protection Program (PPP), which provided forgivable loans to small businesses to pay salaries, utilities, rent and the like, could use replenishment. And state and local budgets remain in dire need of federal assistance, particularly as many schools nationwide have reopened.
Unfortunately, it appears no fresh federal aid is forthcoming. Complicating matters is that neither the Republican-led Senate nor the Democratic-controlled House seems to want a deal badly enough to make meaningful concessions to the other side. This dynamic is unlikely to improve as the election nears and politicians choose campaigning over being in the “room where it happens” (or, in this case, the room where it doesn’t).
Because we’re still waiting for key consumer data reports for August, it’s hard to fully gauge the impact these diminished or depleted federal programs have had on consumer behavior. We’ll begin to find out on Wednesday, with the release of August retail sales. (Last month’s consumer spending data, however, won’t be available until October 1.) In the meantime, here’s a potentially ominous harbinger: The Conference Board’s index of consumer confidence plunged to a six-year low in August.8
Fortunately, there’s been some positive economic news to report. August’s 1.4 million increase in payrolls should provide a counterweight to the falling incomes from smaller unemployment checks. And the high household savings rate (17.8% as of July) may enable consumers to spend more in the future.9 Consumers may also find themselves feeling wealthier as their nest eggs — and depending on where they live, their home values — have increased. So it’s important to look at the reduced fiscal support not in isolation but in the context of other data when evaluating the potential impact on consumer spending and the overall economy.
While government relief was generous when it was needed most during the spring, the “cold turkey” approach to stopping government aid in August was, to say the least, not ideal. Still, millions more Americans are working and collecting paychecks now compared to four months ago, and consumer spending (through July, anyway) has risen considerably since plunging in March and April. Against that backdrop, is the U.S. economy strong enough to make it through the next few months without any federal fiscal aid?
The answer is …most definitely maybe.
Depending on the outcome of the election, Congress could pass a much larger fiscal package in 2021 than any currently under consideration. Such a bill might include funding for infrastructure projects and renewable energy, as well as more direct aid to state and local governments.  And that stimulus, were it to become law, could provide a nice overall boost to economic growth next year and – dare we say it? – a “lightning bolt” shaped recovery pattern, with slower GDP growth in the fourth quarter of 2020 and the first quarter of 2021, followed by bigger gains the following two quarters. Add a widely adopted and effective COVID-19 vaccine into the mix, and the potential economic surge would be even larger.
  1. Factset
  2. Nuveen
  3. Bloomberg
  4. Bloomberg
  5. Bloomberg
  6. AAII (Bloomberg)
  7. ICI (Bloomberg)
  8. Bloomberg
  9. Haver