2020 Mid-Year Outlook: The Storm Before the Calm – The Sequel

Douglas Cote

Douglas Coté, CFA

Senior Portfolio Manager, Head of Global Perspectives

Executive Summary

  • A blockbuster quarter in equities was capped off with encouraging economic readings, but hold the fireworks!
  • Massive global monetary and fiscal stimulus led by the U.S. was much needed and hit its mark
  • The S&P 500 price is 25 times 2020 earnings compared to its historical average of 15 times
  • Corporate earnings look ominous for the balance of 2020, but optimism for next year is building
  • The pendulum has swung from low regulation to high regulation induced by COVID-19 hysteria
  • Record high deficits risk record high taxes, reducing prospective capital investment, jobs and economic growth

Blockbuster is the only way to describe the second quarter 2020. The Dow Jones Industrial Average exploded to its best quarter since 1987 and the NASDAQ had its best since the dotcom boom of 1999. The economy was no slouch either, having entered the up-side of a V-shaped recovery by capping the quarter with strong positive surprises in non-farm payrolls, ISM Manufacturing and ISM Services reports. However, while this is all quite extraordinary considering the extreme, pandemic-driven Bear market, we should hold the celebratory fireworks as both the markets and economy are fragile and remain in contraction. Indeed, some wider perspective is warranted.

Figure 1. Manufacturing surprised to the upside

Chart showing global manufacturing PMIs

Source: Institute of Supply Management, FactSet. The Purchasing Managers’ Index (PMI) is an indicator of economic activity in the manufacturing sector. Measures above 50 indicate economic expansion, measures below 50 indicate economic contraction. PMI’s as of 06/30/2020, Industrial Production as of 04/30/2020.

First, the markets and economies are applauding the massive stimulus from global central banks led by the U.S. Federal Reserve. In September 2019, the Fed’s balance sheet was $3.8 trillion. Yet by July 2020 it hit $7 trillion – nearly double. It might seem extreme, but it was necessary, as credit markets were freezing up, including the venerable U.S. Treasury markets – an unacceptable condition. Meanwhile, the budget deficit exploded via U.S. Congressional spending on the 2020 Cares Act and its “Main Street Lending Program” to small and mid-sized businesses. Remember when a $1 trillion budget deficit was shocking? Well, now the Congressional Budget Office estimates a $3.7 trillion budget deficit for 2020! Understandably, the bond rating agencies may be questioning U.S. fiscal health.

For Fiscal year 2020, Treasury receipts from individual and corporate taxes paid are expected to plummet by 16% due to the recessionary impact on profits and wages. To make matters worse, while tax receipts drop, government payments for pandemic relief and more are expected to increase by 48%. This fiscal mismatch of less revenue inflow and greater expenditure outflow slows growth for many reasons but, mainly because big deficits require big tax increases that adversely impact future economic and corporate earnings growth.

Corporate earnings – which are the fundamentals that drive markets – are expected to fall in 2020 to $124 per share from 2019’s $163 per share; a 23.8% earnings decline. Meanwhile, the S&P 500 is off roughly a mere 2.5% as of this writing. Such a disconnect between price and earnings reveals a very pricey market at twenty-five times earnings compared to the historical average of fifteen times earnings – a stunning 66% premium. Valuation is a poor predictor of stock market returns… until it gets to extremes, like it is currently inching towards. So, let’s give the market some credit in looking past 2020 and discounting 2021 earnings growth instead. The clarity on 2021 expected earnings is a stretch but is projected to bounce back to $163 per share – same as in 2019. But even when using this higher number, the market is still valued expensive at 19.5x P/E.

Figure 2. Fundamentals Drive Markets

Earnings growth of the S&P500 is a key indicator of health for the overall stock market.

chart showing earnings growth as a key indicator of health for the overall stock market

Source: Refinitiv – Thomson Reuters and FactSet, Voya Investment Management. Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of common stock. The S&P 500 index is a gauge of the U.S. stock market that includes 500 leading companies in major industries of the U.S. economy. Past performance is no guarantee of future results. Indices are unmanaged and not available for direct investment.

It gets worse. The top 25 stocks (or 5% of the names) in the S&P 500 accounted for 58.3% of its 20.5% total return for the second quarter of 2020. Whereas, the bottom 250 stocks (or 50% of the names) accounted for a mere 10% of the overall return. This size risk is evident also by year-to-date returns for large-, mid- and small-cap equities, where large-cap outperformed mid- and small-cap by 9.7% and 14.8% respectively – in six months! It is not the 1999 dotcom Bull Market that comes to mind, but the subsequent “Tech Wreck”, which was the worst Bear Market since the Great Depression at the time and lasted for three years.

Our outlook for the second half of 2020 notes the following key hindrances for making a case for a fast rebound in corporate earnings:

  • COVID-19 is accelerating as fast as Re-Opening America
  • Mega-disruptors like Zoom-style technologies are helping to spur an exodus from urban areas and crush business travel
  • State and Federal government COVID regulations are a major impediment to normal functioning small, mid and large business, and act as an anchor to jobs, tax receipts, economic growth and, most importantly, corporate earnings

However, these adverse reactions are mitigated by not just U.S. Federal Reserve and Federal Government stimulus, but also global central banks and their respective governments, notably in Europe, China and Japan. Indeed, new stimulus currently under discussion:

  • It was announced in June that the Trump administration is preparing a nearly $1 trillion infrastructure proposal to include road, bridges, rural broadband and 5G wireless infrastructure1
  • Payroll tax holiday to spur consumer spending
  • An additional round of pandemic relief to extend current programs

These would certainly get the markets jolted upward and spur the economy but, the question remains how to pay for it. Don’t expect Congress to offer higher taxes anytime soon, but simply the expectation of higher taxes will have a deleterious impact.

Market Review Q2 2020

The market in the second quarter of 2020 blazed at a speed not seen for over 20 years. The tide that came in “lifted all boats,” to coin Warren Buffet. The Federal Reserve was instrumental in providing a bulwark against credit markets that were on the precipice of imploding – even U.S. Treasuries. The equity market took its cue and gapped up significantly in what could only be aptly categorized as the remedial effect of the “triage.”

While U.S. mid-cap equities were the best performing asset class, returning 24.1%, it was Emerging Markets that caught the investors’ attention with its blistering return of 7.4% in June – more than double its nearest competitor – to end the quarter with an 18.2% gain. Its name may have to change since according to Blackrock 76% of the MSCI’s Emerging Market Index is in Asia, and half of that comes from China. The trajectory of China shares continues unabated in the third quarter, up over 27% year-to-date as of July 8. Large-caps via the S&P 500 deserve mention, having shown the best quarter in about twenty years with a 20.5% return.

In Fixed Income, credit markets were rescued by the U.S. Federal Reserve, which in addition to adding gargantuan liquidity were also creative with new innovative ideas. The first was buying Blackrock iShares credit ETFS, most notably the “iShares iBoxx$ Investment Grade” ETF, more widely know by its ticker “LQD”. This buying activity had its intended effect of boosting returns substantially during the quarter. A month later, as part of the CARES Act’s “Secondary Market Corporate Credit Facility” started buying its choice of corporate bonds from the secondary market. While the markets are treating this slew of monetary and fiscal actions as a “free lunch,” we’re cautioning investors to watch for price action in “alternative reserve currencies” such as gold. Gold is nearly at the 2011 high of $1,814 when the U.S. government saw its first-ever credit rating downgraded by Standard & Poor’s.


Figure 3. Global effective diversification has beaten the S&P 500 over a long period of time

Table that shows the effect of global diversificaton

Source: FactSet, FTSE NAREIT, Voya Investment Management. The Overall Average model allocation includes 10 asset classes, equally weighted: S&P 500, S&P 400 Midcap, S&P 600 Smallcap, MSCI U.S. REIT Index/FTSE EPRA REIT Index, MSCI EAFE Index, MSCI BRIC Index, Bloomberg Barclays U.S. Corporate Bonds, Bloomberg Barclays U.S. Treasury Bonds, Bloomberg Barclays Global Aggregate Bonds, Bloomberg Barclays U.S. High Yield Bonds. Returns are annualized for periods longer than one year. Past performance is no guarantee of future results. An investment cannot be made in an index.

Conclusion: 2020 Mid-Year Outlook

The bottom-line is corporate earnings, which have gone from bad to ugly. First quarter is in and earnings compared to a year ago dropped by more than 12 percent. Pretty bad considering the pandemic didn’t really hit the U.S. hard until March. The second quarter that will soon report is really ugly and bore the brunt with consensus expectations at -43% earnings growth compared to a year ago. On July 2, the non-farm payrolls report saw its second blockbuster in a row and the markets celebrated. Yet, the unemployment rate still has an 11%-handle on it, which is like NFL football players high-fiving on a good play when they are still down by 42 points. The good news for markets is that there are novel forms of stimulus that are being implemented or have yet to be tried. It is true more than ever that “Fundamentals Drive Markets” and that is how Global Perspectives invests.



This commentary has been prepared by Voya Investment Management for informational purposes. Information should not be construed as legal, tax, or financial planning advice. Investors should seek the guidance and advice of their own legal and tax counsel. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) changes in laws and regulations and (4) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.

Past performance is no guarantee of future results.