Stocks wiped out last Friday’s gains over the week, as virus concerns re-emerged and the Fed offered a downtrodden view of the economy looking forward. The rapid reopening trade saw steep reversals, with investors fearing once again that the recovery could be slow and arduous. Increasing cases of COVID in the US since the reopening, particularly in those states that had eased restrictions most, raised fear that the healthcare system could be overwhelmed in new hotspots, similar to what was seen in New York. As consumers anxiously go back to their old ways without continuing to take precautions, the likelihood of more spread continues to rise. Until a vaccine can be found, the virus could remain a permanent fixture in society and the economy, hampering any hopes for a robust rebound in growth.
Adding to the negative view this week was the Federal Reserve, which expressed doubts that the recovery would be swift and inclusive. The Fed pledged Wednesday to continue pumping stimulus into the economy for as long as necessary to support the labor market until it can heal from the pandemic. They also suggested that rates will be held near zero through 2022 at a minimum. Officials at the Fed see unemployment at just under 10% by the end of the year, and a contraction in GDP of over 6% this year, followed by a rebound of 5% in 2021. Meanwhile, inflation is expected to remain below the 2% target for some time, despite the stimulus measures in place. The Fed is also rapidly expanding its lending program to small main street businesses, who need support now more than ever. Meanwhile, Congress has stalled any talks aimed at pushing for more government aid and spending to help smooth over the hole created by the virus, seen as critical by market participants to keep the economy afloat.
Many are attributing the current plunge to a consolidation after an overheated market had runaway with momentum carrying it too far too fast. Much speculation has been made that the recent run up has been on the back of mom and pop investors who have been day trading, some using margin. An increase in retail trading is likely, given the recent switch to free trading on many popular platforms, and some of the stocks seeing significant buys were those companies facing bankruptcy, airlines and hospitality companies, and other extremely speculative trades. Major institutional investors meanwhile have been sitting on the sidelines, believing the market had run ahead of itself. The early winners in the rally, technology and healthcare stocks, have held up significantly better than those of other sectors, whose fortunes are directly tied to a quick reopening. The recent reallocation to value, cyclical, and small company stocks has seen an unwind, as investors flee back to those more defensive sectors.
Given the massive run-up in equity prices over the past several months, we think it is prudent to reduce overall risk exposure marginally, as there appears to be some froth at current levels. We believe that risk is skewed to the downside given the risks to the recovery, including a second wave, geopolitical uncertainty, and the looming Presidential election. As stated before, we have not made any significant additions to risk assets, believing that markets’ disconnect with the economy had reached too much of an extreme. That said, unprecedented central bank support for financial conditions will likely continue to provide a floor to asset prices. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.