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5 Factors Influencing the Stock Market
The strength of the second-quarter rally in equities came as a surprise to many investors. As the quarter-end approaches, there is heated debate between bullish and bearish investors about the outlook for the remainder of 2020. Bullish investors cite the gradual easing of social distancing restrictions and massive policy support as fuel for a durable stock market recovery.
Bearish investors cite the recent surge of COVID-19 cases as an indication that the nascent economic recovery will be short-lived, increasing the likelihood of a stock market correction. Given the high level of uncertainty and the potential for emotions to overcome rational thought, investors should consider the five factors likely to influence the path for equities:
1. Activity and mobility measures. There may be big differences between what people are “allowed” to do and what they are willing to do as lockdowns are relaxed. Activity and mobility measures provide early indications of changes in behavior, measuring activities such as trips to work, use of public transportation, shopping in retail stores, dining out at restaurants and hotel stays. Activity and mobility measures provide important clues about the trajectory of economic recovery post-lockdown. The pace and magnitude of the rebound in activity will have a significant influence on equity returns for the remainder of the year, as there won’t be normalcy until there is a COVID-19 vaccine.
2. The mathematics of recovery. Headline numbers can be deceiving. In an environment where economic activity has collapsed at a nearly unprecedented rate, eye-catching numbers during the recovery phase may create excessive exuberance. For example, a rebound of 25% in an indicator may look significant. But if that indicator declined 50% in the prior period, the level of the indicator would still be nearly 40% below the pre-pandemic level. In that context, the recent rebound in employment and retail sales may be less impressive.
3. State government response to the virus. One factor contributing to the market rally is the expectation that state leaders are unlikely to reinstitute the lockdowns that decimated economic growth in April and May. Investors expect states to respond to rising infections by slowing the pace of reopening and tightening social distancing protocols. State governments could rethink their plans if hospitalizations, strains in the health care system and death rates surge in more of the country. Public statements from governors and mayors may provide advance warning of shifts in sentiment toward a resumption of lockdowns.
4. The next federal fiscal package. The $3 trillion aid bill passed by the U.S. House of Representatives in May has virtually no chance of becoming law, but Congress is likely to provide additional financial assistance to reduce the economic harm from the pandemic. Aid to state and local governments, burdened by pandemic-related revenue losses and cost increases, is likely to be forthcoming. Without federal help, many state and local governments will find themselves in a budget crunch that could force drastic spending or service cuts. There is some opposition to providing aid to state governments because states such as Illinois and New Jersey face pension-funding deficits that are unrelated to the pandemic.
Assistance to state and local governments will probably be attached with conditionality, preventing the aid from being applied to pension funding shortfalls. Additional help for small businesses and extension of unemployment benefits for workers will also be on the table for discussion, though there will be heated debate about the merits of extending the $600 “bonus” for unemployment benefits.
5. Election watch. Investor consensus is that President Donald Trump will continue to blame China, but policy moves before the election might be “all bark and no bite.” In the view of many investors, Chinese commitments to buy American agricultural products and the importance of the Chinese market to U.S. multinationals will dissuade Trump from following through on many of his threats. However, if Trump believes he is trailing in the election race after Labor Day, the odds of an “October surprise” will rise. Under that scenario, relations between the U.S. and China could degenerate further, with an even more direct economic conflict.
Investors will also be evaluating the likelihood that a victory by former Vice President Joe Biden would have long enough “coattails” to keep Democratic control of the House and whether it’s possible to flip the Senate to Democratic control.
The ultimate game-changer for the world would be a breakthrough in the treatment or prevention of the coronavirus. In the absence of such a breakthrough, investors need to manage their emotions associated with the pandemic to assess the outlook for equities objectively. It may be easier said than done, but is worth the effort.
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