Weekly Investment Update

US equities, as measured by the S&P 500 index, advanced nearly 1% last week heading into Memorial Day weekend.  Investors continue to grow optimistic regarding the potential for a COVID-19 vaccine as well as the resumption in economic activity as stay-at-home orders and business closures are relaxed.  Despite the unprecedented decline in the US economy that is still unfolding, the S&P 500 index is only down 8% for the year and 13% from its all-time closing high of 3,386 set on February 19 (Chart 1). 

Chart 1: S&P 500 Price Index

Source: JPMorgan Guide to the Markets

When looking at analysts’ consensus expectations for earnings over the next twelve months, the S&P 500 index appears expensive relative to history at 21x expected earnings (Chart 2).  However, analysts and investors appear to be increasingly optimistic that the recession caused by the COVID-19 virus will be short-lived and earnings will reach 2019 levels in 2021 and increase more than 10% in 2022 (Chart 3).  So, the index currently trades in expensive territory at 23x expected 2020 earnings, but these levels may be more reasonable if significant earnings growth can be achieved in subsequent years, which would imply that the S&P 500 is currently trading at 18x expected 2021 earnings and 16x expected 2022 earnings. 

Chart 2: S&P 500 Forward Price-to-Earnings Ratio

Source: JPMorgan Guide to the Markets

Chart 3: S&P 500 Historical and Expected Earnings

Source: JPMorgan Guide to the Markets

Last Thursday, the Conference Board released results for its Leading Economic Index for April.  Below is an excerpt of the commentary from the organization’s Senior Economists (our emphasis added):

“In April, the US LEI continued on a downward trajectory, after posting the largest decline in its 60-year history in March.  The erosion has been very widespread, except for stock prices and the interest rate spread which partially reflect the rapid and large response of the Federal Reserve to offset the pandemic’s impact and support financial conditions.  The sharp declines in the LEI and [Coincident Economic Index] suggest that the US economy is now in recession territory.  Business conditions may recover for some sectors and industries over the next few months, but the breadth and depth of the decline in the LEI suggests that an imminent re-opening of some sectors does not imply a fast rebound for the economy at large.”[1]

Chart 4: Leading Economic Index

Chart 4 shows the historically sharp decline in the US LEI caused by the COVID-19 virus.  The index has 10 components that include measures of manufacturing, employment, housing, stock market activity, financial conditions, and consumer expectations.  Absent the “rapid and large response of the Federal Reserve” which significantly reduced borrowing costs and likely fueled much of the stock market rally since late March, April’s LEI reading would have been much worse.  This relationship between lofty stock prices and expectations juxtaposed against historically bad economic activity is challenging.  Given that stock market investors behave in an anticipatory way by pricing securities based on expected future cash flows, equity markets typically do, on average, peak and trough approximately six months in advance of peaks and troughs in the economic cycle (Chart 5).

Chart 5: Historical Relationship Between Economic & Stock Market Cycles

The swift recovery in equity prices witnessed since late March implies that investors expect that the economic cycle will turn relatively soon.  And, there has been evidence of some signs of life in cyclical sectors as stay-at-home orders and business closures are relaxed.  For example, high frequency data such as the number of passengers screened at US TSA checkpoints, while still down significantly from a year ago, has tripled in the last month.  Mortgage applications and restaurant visits have begun to improve as well.[2]  Though they may be nascent, these indicators may imply that the economic contraction could be in a bottoming process.

[1] https://www.conference-board.org/pdf_free/press/US%20LEI%20PRESS%20RELEASE%20-%20MAY%202020.pdf

[2] https://www.wsj.com/articles/for-economy-worst-of-coronavirus-shutdowns-may-be-over-11590408000

Key Economic Releases This Week

Source: Marketwatch

Asset Class Returns

Source: Morningstar, Bloomberg, US Treasury (total returns shown gross of fees)
As of May 22, 2020

Prices & Interest Rates

Source: Morningstar, Bloomberg, US Treasury (total returns shown gross of fees)
As of May 22, 2020

Past performance may not be representative of future results.  All investments are subject to loss.  Forecasts regarding the market or economy are subject to a wide range of possible outcomes.  The views presented in this market update may prove to be inaccurate for a variety of factors.  These views are as of the date listed above and are subject to change based on changes in fundamental economic or market-related data.  Please contact your Financial Advisor in order to complete an updated risk assessment to ensure that your investment allocation is appropriate.