Morgan Stanley
  • Wealth Management
  • Aug 24, 2020

What to Make of the Market’s Record Round Trip

Investors take note: The S&P 500’s recent gains may have outrun real improvements in the U.S. economy and equity fundamentals.

Lisa Shalett Chief Investment Officer, Wealth Management

In mid-August, the S&P 500 completed what may be the most remarkable comeback in stock market history. After hitting a record high of 3380 on Feb. 19, then plunging 34% to a pandemic-induced low of 2237 on Mar 23, the benchmark index of the broader U.S. market took just five months to make a round trip—and set a new record of 3395.

Manage your Wealth

Find a Financial Advisor, Branch and Private Wealth Advisor near you

Does that mean the recovery stage of this new business cycle has transitioned to an expansion phase? We think not, and here are three main reasons:

  • S&P 500 gains are concentrated in a handful of stocks. The five largest names, mostly tech and social media companies, now comprise a historic 25% of the index. That group is up 30% year to date, but the median stock is down 7%. The result is an index that is not only expensive—the forward price-earnings (P/E) ratio is 23, near the extremes of the 1999 tech bubble—but also very top-heavy. Lower interest rates may seem to justify high valuations, but if inflation picks up as the recovery progresses, those rates will likely rise and create market headwinds.
  • The market seems disconnected from the economy. While markets tend to anticipate the future, expectations may be getting unrealistic. We see lots of data supporting a V-shaped recovery—with solid green shoots in housing, durable goods orders and manufacturing—but the recession isn’t over. Unemployment remains over 10%; even a 20% jump in GDP growth in the third quarter would return the economy to a level still 9% below where it stood in January. We don’t expect GDP to fully recover until the second quarter of next year and doubt that corporate profits will significantly outpace that rate. As for the market leaders, stay-at-home pandemic conditions may have pulled forward years’ worth of their future growth, rendering current investor expectations unachievable for those names.
  • Investors seem overly complacent about potential risks. Individual investors seem somewhat subdued, but institutional investors have moved to max-bullish sentiment, with put/call ratios (technical indicators based on options contracts) at seven-year lows (a low number indicates investors expect stocks to rise). Such complacency seems odd, given high uncertainty about the next phase of fiscal stimulus—now apparently on hold until after Labor Day. Although the outlook may have improved on COVID-19 infection rates and a vaccine, the pandemic’s trajectory remains in doubt. The U.S. presidential election, where possible outcomes are very much in flux, represents another major unknown for markets.

We are in a new bull market, but we urge investors to be patient and prudent right now and not chase winners.

Consider using this time to prepare tax-efficient investing strategies, such as harvesting losses to offset gains in expensive winners. We expect markets to be mostly range-bound over the next three months of uncertainty and think small caps, value-style and cyclical stocks will return to favor. Meantime, watch market breadth, valuations and economic fundamentals for signs that the market is reaching new extremes.

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from Aug 24, 2020, “Implications of the Record Round Trip.” Ask your Financial Advisor for a copy or find an advisor.  Listen to the audiocast based on this report. 

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not be offered or sold absent an exemption therefrom.  Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

 

Disclosures

Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy.  Past performance is not necessarily a guide to future performance.

The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.  Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this material.

This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument.  That information would contain material information not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter.  We have no obligation to tell you when information herein may change.  We make no representation or warranty with respect to the accuracy or completeness of this material.  Morgan Stanley Wealth Management has no obligation to provide updated information on the securities/instruments mentioned herein.

The securities/instruments discussed in this material may not be suitable for all investors.  The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.  Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors.  Estimates of future performance are based on assumptions that may not be realized.  Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the projections or estimates.  Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.  Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not materially differ from those estimated herein. 

This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is not intended to, and should not, form a primary basis for any investment decisions that you may make. Morgan Stanley Wealth Management is not acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue Code of 1986 as amended in providing this material except as otherwise provided in writing by Morgan Stanley and/or as described at www.morganstanley.com/disclosures/dol.

 

Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice.  Each client should always consult his/her personal tax and/or legal advisor for information concerning his/her individual situation and to learn about any potential tax or other implications that may result from acting on a particular recommendation.

 

This material is disseminated in Australia to “retail clients” within the meaning of the Australian Corporations Act by Morgan Stanley Wealth Management Australia Pty Ltd (A.B.N. 19 009 145 555, holder of Australian financial services license No. 240813).

Morgan Stanley Wealth Management is not incorporated under the People's Republic of China ("PRC") law and the material in relation to this report is conducted outside the PRC. This report will be distributed only upon request of a specific recipient. This report does not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors must have the relevant qualifications to invest in such securities and must be responsible for obtaining all relevant approvals, licenses, verifications and or registrations from PRC's relevant governmental authorities.

If your financial adviser is based in Australia, Switzerland or the United Kingdom, then please be aware that this report is being distributed by the Morgan Stanley entity where your financial adviser is located, as follows: Australia: Morgan Stanley Wealth Management Australia Pty Ltd (ABN 19 009 145 555, AFSL No. 240813); Switzerland: Morgan Stanley (Switzerland) AG regulated by the Swiss Financial Market Supervisory Authority; or United Kingdom: Morgan Stanley Private Wealth Management Ltd, authorized and regulated by the Financial Conduct Authority, approves for the purposes of section 21 of the Financial Services and Markets Act 2000 this material for distribution in the United Kingdom.

Morgan Stanley Wealth Management is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the “Municipal Advisor Rule”) and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.

This material is disseminated in the United States of America by Morgan Stanley Smith Barney LLC.

Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data.

This material, or any portion thereof, may not be reprinted, sold or redistributed without the written consent of Morgan Stanley Smith Barney LLC.

© 2020 Morgan Stanley Smith Barney LLC. Member SIPC.

CRC#3213322 (8/2020)

View disclosures