Business Investment
In this uncertain environment, businesses are pulling back on investing in future growth. But we have seen encouraging signs here as well in terms of a solid rebound in small business confidence in the future, based on the latest National Federation of Independent Business (NFIB) small business survey of expectations. New orders components of the Institute for Supply Management (ISM) surveys for May improved for services and manufacturing as businesses reopen. However, as with unemployment, manufacturing data for May remained at recessionary levels and will probably remain there in June.
The road to recovery will be gradual, as businesses are thoughtful and deliberate about making long-term capital investment commitments and will need to learn more about how the restrictions impact their business as a vaccine gets closer. Moreover, decisions for some industries could also be delayed until they have greater clarity on the post-election policy environment.
Policy Stimulus
Policymakers prevented a deep recession from getting much deeper with an extraordinarily fast and bold response. The four stimulus packages passed already have totaled nearly $3 trillion, and a fifth package is in the works that could add another $1 trillion to that total. In total, that’s potentially 16% of GDP in fiscal stimulus support as a bridge to the other side of this crisis and to help ensure the recovery is a strong one. The Federal Reserve has been similarly bold, increasing its balancing sheet by about 13% of GDP, and signaling that the central bank may hold its policy rate near zero well beyond 2020.
Conclusion
We remain optimistic about a gradual recovery in the second half, though forecasting in a COVID-19 environment remains very difficult. We are encouraged by recent signs of improvement in the labor market and some of the timeliest data on economic activity. However, there are constraints on the pace of recovery in the second half. The next leg gets tougher and a swoosh seems an appropriate shape.
Finally, we are maintaining our year year-end 2020 fair value target range for the S&P 500 at 3,150-3,200, based on a price-to-earnings ratio (PE) of about 19 and a normalized earnings figure of $165, even though the index closed within that range on Friday. We continue to believe stocks are pricing in an overly optimistic outlook for a second half economic and profit recovery and expect a pullback in the near term.
For long-term investors, we still find stocks more attractive than bonds at current valuations and recommend overweight allocations (and a corresponding underweight to fixed income).
Jeffrey Buchbinder, CFA, is an equity strategist at LPL Financial.