Looking Ahead for Investments
2020 has been a very challenging and extraordinary year. As of Nov 25, there have been over 60 million people infected with the Coronavirus and over 1.4 million deaths. Each of those people represents someone with family and loved ones and we feel for their losses. The resulting economic shutdowns created a deep recession that we are still recovering from and which has been very difficult for many people. Massive fiscal and monetary stimulus from governments around the world softened the blow. And yet, the sharp correction for stocks has had a remarkable recovery to new market highs. So, what is next and how can we position our investments to continue to do well?
Because of how severe the recession was, and the fact that we do not have a more permanent solution to the virus yet, the next part of the economic recovery should be gradual. Until there is a broad distribution of a safe and effective vaccine, economic activity is likely to remain below pre-pandemic levels. It is expected economic output may not reach its 2019 peak level until late 2021.
Part of the reason for this that in the US, consumption drives nearly 70% of the economy, and with many service-oriented businesses only reopened partially, and with high unemployment reducing households’ ability to spend, the engine of the economy is impaired. Industries such as hospitality, travel, and leisure are struggling. Some areas of the economy, however, like housing and autos, and online shopping have been able to rebound strongly. The fact that these areas are doing well, and that the market has seen that the economy does recover quickly are what are driving the returns. The markets are looking to the future.
Profits should gradually improve from here
Analysts are expecting profits to recover in 2021, but past earnings recessions have typically lasted 2-3 years, and given the severity of the plunge in profits and the gradual economic recovery, it may be that profits will not surpass their 2019 peak until 2022.
Higher inflation is a risk down the road
The onset of the recession, combined with a collapse in oil prices, has triggered a decline in already low inflation. Although inflation normally troughs after the end of a recession, things may be a little different this time around, particularly given the potential for further economic stimulus after the US election, the continuing extra costs of operating during a pandemic, and the likelihood of an economic surge post-pandemic.
Low for even longer
With the government interest rates are record lows, expectations for low-interest rates for long again, and challenges to growth ahead, nominal Treasury yields have fallen to historic lows and real returns are negative. In this low rate environment, investors will continue to have a difficult time looking for return with their fixed income. However, despite low yields, high quality fixed income will continue to play an important role in providing investors with downside protection and diversification.
U.S. equities have recovered significantly
U.S. equities have recovered significantly from the March lows, and at record speed. However, investors should recognize that any valuation based on earnings over the upcoming year will look high given the unusually deep recession. While markets may experience volatility ahead with risks such as a resurgence of the virus, ultra-low rates and support from the Federal Reserve provide meaningful support to stocks.
International stocks offer long-term opportunities
Both U.S. and international stocks sold off at the height of the COVID crisis, but the valuation gap between U.S. and international stocks that persisted throughout the recent expansion still persists today. However, this dynamic could shift in the next expansion.
The long-term growth prospects of emerging market economies may look better than for the U.S., valuations remain cheaper overseas, and the US dollar has been retreating, which increases the return on international equities. Europe, which has been long less popular as an investment, may have a catalyst for turnaround with more promising effort.
Risks ahead call for diversification
Despite a rebound in markets, the economic, labor market, and earnings recoveries will likely be much slower going forward until there is a vaccine. With additional risks ahead such as a resurgence of the virus and the continued uncertainty in the world, investors would likely benefit from a focus on quality in equity and fixed income, with a balanced approach to confront a range of outcomes. As always, a diversified portfolio provides the best downside protection with opportunities for gains.
Source: JP Morgan Asset Management as of October 30, 2020