6. Election prospects are trending in the Democrats’ favor. Per the PredictIt predictions market, Donald Trump had a 59% chance to win reelection one month ago. That has since fallen to 46%. Likewise, the chance of Republicans holding the Senate fell from 73% to 53% and the chance of the House staying Democratic has risen from 57% to 75%.
7. We think the impact on economic growth will be extremely sharp but hopefully short lived. Economists’ second quarter growth predictions are shifting wildly, currently somewhere between -10% to close to -25%. Our best guess at this point is first quarter growth down around -5% and second quarter growth down between -10% and -15%. If the crisis passes in a few months, third and fourth quarter growth could rebound to between 5% and 10%. We also think the current 3.5% unemployment rate could double, but also hopefully recover quickly.
8. The direction of equity prices will depend on how badly corporate earnings are damaged. In a normal recession, corporate earnings tend to fall somewhere between 15% and 20%. If 2020 earnings are down 20%, that would equate to $132 for the S&P 500.1 And with valuations around 18 times earnings, that would put the value of the S&P at 2,350 (which is about where it is right now).1 The key will be the eventual upturn. If 2021 earnings rebound to $160 and valuations fall to 16 times earnings (which would be reasonable in a quick recovery), that would put the 2021 level of the S&P 500 at 2,550.1 That would, in turn, represent a 10% gain from current prices. Of course, all of this is hypothetical, but it provides a framework for forecasting possible price levels.
8. We think stocks remain in a bottoming process. We had previously hoped that 2,350 (the level the S&P reached in December 2018) would be the low, but stocks broke through that level on Friday.1 Nevertheless, technical factors still suggest stocks are bottoming. The number of new lows has been very high, put/call ratios are at extremes, volatility appears to have peaked and forced selling by leveraged hedge funds and risk-parity funds may be exhausted. However, bottoming is a process, not an event, meaning this could take some time.
9. Financial market internals suggest depressed areas could be poised for a sharp rebound during an eventual recovery. Given how sharply bond yields have fallen, the yield relationship between stocks and bonds is more advantageous for stocks than at any time during the last 65 years. At the same time, the valuation spread between value and growth is at extremes only topped by the Great Depression and the recent financial crisis. We’re not calling a bottom, but these relative valuation spreads make us think that stocks should outperform bonds and value will beat growth over the next 12 months.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen.
1 Source: Bloomberg, Morningstar and FactSet
2 Source: Federal Reserve
3 Source: Department of Labor