Morgan Stanley
  • Wealth Management
  • May 18, 2020

U.S. Markets Are Unlikely to Return to March Low

The S&P 500 seems range-bound between the February high and March low. Here’s why it may stay there for a while.

Lisa Shalett Chief Investment Officer, Wealth Management

In the past three months, investors have experienced a remarkably steep stock market plunge and an impressive snapback, followed by approximately three weeks with the S&P 500 bouncing around a trading range of 2800 to 2950. I expect this phase to continue for the next three to six months.

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Excitement that social-distancing measures were helping to contain the spread of COVID-19 has given way to the reality of profound economic damage—record levels of unemployment, collapsing demand and poor consumer confidence readings. Stock valuation measures based on corporate fundamentals have become unreliable, as 40% of companies have stopped providing earnings guidance. 

I worried in April that U.S. stocks had moved too far, too fast and still think that there is a chance for as much as a 10% correction from here, as trade tensions and partisan politics resume. Nonetheless, I don’t subscribe to the bearish narrative that the S&P 500 will retest the March lows. Here are three key reasons why:

  • Massive amounts of direct government and monetary stimulus are in place. Congress has passed trillions in aid and may provide more. The Federal Reserve has also provided unprecedented levels of stimulus. Fed Chair Jerome Powell recently quashed concerns about the Fed taking interest rates into negative territory, allowing the yield curve, an important economic indicator based on interest rates, to steepen (a good thing, as it signals bond market expectations of future economic growth).  
  • Consumers should prove resilient. Even though confidence measures have plunged, they aren’t as low as prior recessions. Surveys show that up to 80% of unemployed workers consider themselves temporarily furloughed. If they are correct, long-term unemployment may not be the intractable problem it now seems. Consumer confidence, spending and employment are closely linked. The underlying strength of the U.S. consumer is one reason why I forecast a U-shaped economic recovery.
  • Market technicals, sentiment and positioning argue against sharper declines. Investors, both individual and institutional, remain conservatively invested, with cash on the sidelines that would likely be put to work in a sell-off, potentially creating a floor under stock prices. Sentiment, as measured by the American Association of Individual Investors, is decidedly downbeat, with 53% saying that they are bearish, the highest level since 2013. That’s a contrarian indicator and signals possible gains ahead, if sentiment improves.

While I expect major U.S. market indices to remain in the current range, I see opportunities for active investors to exploit volatility by looking outside the U.S., in small-capitalization stocks and in corporate credit markets. Consider taking profits in prior U.S. winners that could be vulnerable. Investors who remain passively in U.S. indices may experience frustration with the trading range that is underway and likely to continue.

This article is based on Lisa Shalett’s GIC Weekly report from May 18, “Home in the Range.” Ask your Financial Advisor for a copy or find an advisor. Listen to the audiocast based on this column.

 

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.

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