The first half of 2020 was one of the strangest in recent memory, and the COVID-19 outbreak rages on in the U.S. and around the world. However, Wall Street actually held up fairly well in a volatile first half of the year, with the SPDR S&P 500 ETF Trust (NYSE: SPY) down just 2.2% overall after the Federal Reserve stepped in with unprecedented stimulus measures.
All the economic uncertainty has investors concerned about how the market will perform in the second half of the year. In his new second-half investment outlook report, John Lynch, Chief Investment Officer of Comerica, said there are five keys to how the S&P 500 performs over the next two quarters.
1. The first key is global monetary and fiscal policy.
No matter how severe the economic impact of COVID-19 is on the U.S. economy, Lynch said the Federal Reserve appears to be willing to do whatever it takes to support the economy. He said the Fed is seemingly transitioning from a central bank to a commercial bank as evidenced by its willingness to expand its balance sheet from around $4 trillion to around $7 trillion in only a matter of weeks.
2. The second key issue for stocks is the 2020 U.S. presidential election.
Lynch said President Trump’s poor performance in recent polls suggests stocks could soften heading into the election. Historically, the S&P 500 has performed well heading into the election when an incumbent ends up winning and poorly when the election involves a transition of power from one party to the other.
3. The third issue for investors to watch is updates to the global economic outlook.
Comerica is expecting GDP to fall by 4.2% in the U.S. and 4.9% globally in 2020. However, they're projecting a 4.1% gain in U.S. GDP and a 5.4% gain in global GDP in 2021, suggesting a strong recovery.
4. Interest rates and bonds are the next key factor, according to Lynch.
The Federal Reserve has indicated interest rates will stay near 0% for the foreseeable future, and even 10-year Treasury yields are now under 0.7%. Lynch said he favors investment-grade bonds over high-yield corporate bonds in the current climate given the potential for defaults triggered by the downturn.
5. Finally, Lynch said investors need to watch corporate profits and equity valuations.
He is predicting more volatility from stock prices and higher-than-average stock valuations given expectations for a steep rebound in profitability over the next year.
Unfortunately, even at higher-than-normal valuations, Lynch said he sees very little room for additional upside for the S&P 500 in the second half of the year. He said 3,000 to 3,250 is a fair value for the S&P 500 based on a trailing 12-month PE ratio of around 25.
“Considering that interest rates and inflation are well below historical averages, we believe P/E ratios can exist above historical norms without placing diversified portfolios at significant risk over the long-term,” Lynch wrote.
The divergence between the real economy and the stock market has made lots of investors uncomfortable about the durability of the market rally off the March lows. However, the stock market is forward-looking, and traders shouldn’t overlook the impact that seemingly unlimited Federal Reserve stimulus in support of the market has on investors’ willingness to take risks at much higher valuations.
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