Our analysis last night in Markets showed that for the S&P 500 to move higher we need Financials, Consumer Discretionary (ex Amazon) and Industrials to take the lead from here. The same idea applies to our recommendation to own the Russell 2000, overweight as it is with these cyclical groups.
While we feel good about our constructive view on US stocks, it’s time to play Devil’s Advocate and consider where that optimism could be misplaced. Our mental model here is to imagine the US economy and outlook for corporate profits in December 2020 and then consider what specific catalysts could derail a consistent improvement for both between now and then.
After some brainstorming this morning, we came up with these 10 items:
#1: Unemployment and Labor Force Participation. History says that US unemployment peaks at “X” during recession and then consistently improves thereafter. But the dislocations in this recession are focused in several areas (e.g. hospitality, retail) that employ many lower skilled workers with fewer cross-disciplinary job skills.
#2: Holiday consumer spending. No doubt Holiday 2020 will be far weaker than 2019, but by how much? And will this reduce seasonal hiring needs dramatically and further hurt any labor market recovery?
#3: US Election results, both for the White House and both chambers of Congress. President Trump has been slipping in the polls of late, and now the Senate may be up for grabs. Are markets discounting higher corporate taxes in 2021? They probably should be …
#4: US – China relations in the wake of the 2020 Presidential election cycle.Neither political party has any interest in repairing America’s relationship with China until 2021. While the Chinese leadership knows that, they also have their own base to address and cannot seem weak when criticized by US politicians.
#5: The severity of any COVID – 19 second wave. Peak flu season starts in December in North America. Will Americans want to shop or entertain if the virus is once again a national point of concern?
#6: The possibility of negative Fed Funds rates in 2021. This is one story we wish would just go away, but the Futures market won’t let it go.
#7: The strength/weakness of the dollar. The greenback has weakened a lot in the last month (-4%) on hopes for a global economic recovery. With that, it is still closer to a 3-year high than low.
#8: The extent of a US corporate earnings rebound in 2021. As we’ve outlined recently, the S&P is discounting a 20% increase in earnings next year. That’s what happens in a typical recovery, but nothing seems typical about the current recession (see Point #1).
#9: The pace of economic expansion outside the US. Almost 40% of S&P 500 profits come from outside the US. Rest-of-world economies have to be growing again to get the 20% earnings growth.
#10: The effect of disruptive technologies like automation on structural unemployment and their potentially accelerating impact on old-line companies. This is the issue we think about most. The COVID Crisis sped up a decade’s worth of change on things like work-from-home and online shopping into 90 days. We’ve seen the first order effects, but we don’t yet know the second or third order impacts, let alone how much capital-for-labor substitution will occur in the next 6-12 months.
Summing up: we’re not trying to scare the horses (or you, for that matter), but with the S&P above 3,000 these are the right questions to be asking.