Stocks climbed higher this week, as several promising vaccine studies showed surprising immunity results in trials, and earnings figures continued to roll in, mostly exceeding expectations. In Europe, a groundbreaking agreement was forged within the European Union to authorize a $750 billion dollar recovery package, further integrating the continent’s fiscal response to the pandemic and setting a new precedent with joint borrowing capabilities and a new riskless bond market. Job numbers in the US disappointed, with more filing for unemployment than expected by investors. Meanwhile, COVID cases continue to soar globally, while more areas of the country are invoking or considering further lockdown measures to prevent the spread. These lockdowns are considered a key driver for the weak employment figures, and without the virus under control, could continue to lead to higher claims. In Washington, both sides of the aisle are clamoring for a deal to extend unemployment benefits and continue to support the economy, however, the White House, Senate, and the House remain opposed on the details of a new round of stimulus. A decision must be made soon to avoid a significant hit to the recovery, particularly as rolling shutdowns continue, and with almost half the US labor force dependent on the additional $600 per week they have been receiving since the shutdown began. This has largely been responsible for avoiding a surge in bankruptcies in consumer-oriented companies, as households have been reliant on the stimulus to maintain spending.
A concern that continues to come up from clients is when markets come back down to earth. While this is a reasonable question given the horrific economic landscape and tragedy unfolding with the spread of COVID, we believe that markets are not extraordinarily overpriced at present. In fact, in several ways, stocks look reasonably priced today. Take for example the Fed model, which relates the earnings yield on the S&P 500 to the 10-year Treasury yield to represent how fairly valued stocks are. Theoretically, if the earnings yield is higher than the 10-year rate, the market is bullish, as equities look relatively more attractive. With bond yields suppressed by global monetary policy, and earnings holding up reasonably well on a comparative basis, stocks remain more attractive using that measure. Even versus corporate bond yields, the earnings yield remains higher for most S&P 500 companies. Extending this thought process, if global investors must deploy their capital to maximize their returns, their choices between government bonds yielding less than 1% or stocks with a dividend yield of almost 2% and trading at a price to earnings ratio not wildly higher than it’s historical average, stocks appear to be the better choice. Additionally, if earnings pick up over the next year as the economy reopens, valuations would not appear out of line. Of course, the pace of the recovery and the ability for consumers to return to a quasi-normal life would be required to meet these expectations.
Given the over 45% rebound in equity prices since the bottom in March, and the pace of the bounce-back, we are not adding to our stock allocation at this time. While longer-term we find equities remain attractive, the likelihood for a rise in volatility heading into election season seems high, particularly given the backdrop of a recession and spiking COVID cases. More clarity around the earnings outlook will be necessary before we can call the all clear and boost equity exposure, and we will maintain neutral positioning at present. 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.