Arrow's 2020 Mid-Year Market Outlook

The world looks very different halfway through 2020 then most would have imagined at the start of the year.  Amid social change, political upheaval, economic recession, and a global healthcare crisis, providing a clear vision of the stock market and global economy is difficult at best.  We are in a very abnormal position within the business cycle, as the S&P 500 dropped by nearly 35% between mid-February and late March, only to stage a vast recovery, with the best single quarter performance since 1987.  Despite the rapid recovery during the second quarter, the U.S. officially entered an economic recession in February, fueled by dramatic losses to the Gross Domestic Product (GDP), and rampant unemployment that has peaked over 13%.  But with Covid-19 cases surging in the U.S. during the summer, providing a market forecast for the rest of the year is tenuous at best.  Nonetheless, here are Arrow’s recommendations and thoughts on the market for the rest of 2020:

Volatility is likely as economic recovery might be sporadic

Many investors have probably noticed the increased market volatility in June relative to May.  The rising Covid-19 numbers in many U.S. states has driven additional uncertainty in the market, with many unknowns about the current “shape” of the economic recovery.  The rapid rebound of the S&P 500 indicates that investors are expecting a rapid recovery, but the potential for additional shutdowns, business closures, and weaker demand suggests the market might have reacted too quickly.  Some of these questions will be answered during quarter two earnings reports, where guidance will be provided for expected earnings for the rest of 2020.  We expect additional volatility during quarter two earnings season into the November election period.  We also expect the technology and healthcare sectors to outperform at least through the Fall, with more traditional consumer spending-based retailers to be more affected by rolling shut-downs and temporary closures.

International diversification and re-balancing are key

Arrow continues to advocate for international diversification in all portfolios to mitigate risk due to differential severity of Covid-19 outbreaks in various regions of the world.  Similarly to U.S. stocks, global indexes have undergone a major recovery during quarter two, but the economic consequences of extended shut-downs could lead to a long recovery phase.  A second wave of Covid-19 outbreaks and escalating U.S.-China trade disruption are both potential risks.  Diversification across the U.S., developed non-U.S., and emerging markets is recommended for portfolios with large equity allocations and long-time horizons.  With many potential risks, regular portfolio re-balancing is crucial to limit overexposure to vulnerable sectors, and to realize gains during large upward movements of the volatile markets.

The federal reserve is likely to continue to intervene in the markets

The Fed's buyback program (“quantitative easing”) has purchased over 600 billion dollars in treasuries in some weeks, an amount that exceeds what the Fed would normally buy in nearly a year under previously buyback efforts.  They have even purchased large amounts of corporate bond ETF’s through a partnership with Black Rock Inc, a publicly traded investment company.  This is a line many finance experts didn’t think the Fed would cross, but the fed chair Jerome Powell has increasingly succumbed to political pressure to help stimulate the stock market, despite the poor shape of the economy.  Buying bond ETF’s provides liquidity to major holders of corporate debt, mostly banks.  This props up the price of the bonds (and lowers yields) and frees up cash for banks and other major financial institutions to purchase riskier assets, including stocks.  In simple terms, there is now more money available to purchase equity. This move is unprecedented because it represents over 10 years of liquidity pushed into the market in only a few months, and forces newly free money into riskier assets, which builds up the market through asset inflation instead of real economic growth.

Low interest rates demand elevated risk for fixed income investors

We expect quantitative easing programs to continue, though with renewed allocation toward longer dated bonds.  This will add upward pressure to bond yields, particularly if there are signs of improving economic growth.  Even so, interest rates in treasury yields are likely to remain low for a period of years, which makes safe and consistent income problematic for investors already in retirement.  We suggest a mix of short to middle duration government bonds, investment grade corporate bonds, large cap “blue chip” dividend equity, preferred shares, and international real estate for fixed income investors.  To generate adequate yield, most investors are simply going to need to accept additional risk in their income portfolios.

Investors should stick to their investment plans

Rapid market swings and increased volatility since March have really shown the importance of sticking to an investment plan, re-balancing regularly, and staying disciplined.  Getting on the “wrong side” of a major market swing could mean extensive losses, or periods of waiting in cash as the market recovers at an ever-quicker pace.  Emotional investing and trying to time market bottoms is foolish in today’s markets, especially with the length of economic recovery and vaccine time-frame mostly unknown.  Arrow suggests broadly diversified, balanced portfolios with the use of buffer ETF’s and other market instruments to minimize potential downside for conservative investors.  Investing is about patience.  Stay the course and invest for the long-term.