U.S. equities—tech stocks in particular—have powered higher since March lows, but investors are still parsing Q2 earnings, a coming election and rising COVID-19 cases.
Each week, Mike Wilson offers his perspective on the forces shaping the markets and how to separate the signal from the noise. Listen to his most recent episode and check out those of his colleagues from across Morgan Stanley Research.
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Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, July 13th, at 11:30am in New York. So let's get after it.
Since the March lows, equity markets and virtually all risk asset markets are up a lot. The narrative we've been using to justify these moves has become more consensus at this point and quite frankly, valuations are pretty full, at least for the major indices and especially some of the assets most positively affected by low long term interest rates.
Truth be told, many individual stocks have corrected sharply over the past month. Even the vaunted S&P 500 has not been able to make a new high since June 8th, which is almost five weeks ago. Meanwhile, the Nasdaq and China's main stock market have broken out to new highs for the year, and they appear unstoppable. In the case of China, the excitement is partially due to the fact that they are barely seeing any new cases of COVID-19. New waves are quickly extinguished with aggressive tracing programs and testing. In addition, the Chinese authorities have recently stepped up efforts to stimulate its economy and stock market, even suggesting individual investors should get more invested.
In the US, the COVID-19 situation couldn't be more different. New case counts have moved sharply higher with record new case counts being recorded almost every day over the past few weeks. This is one of the reasons why most US stocks and equity indices have not been able to make new highs since early June. It's also one of the reasons why the Nasdaq has powered higher, even though the S&P 500 has not.
The Nasdaq is comprised mainly of tech and healthcare companies that are viewed as beneficiaries of the pandemic. Working from home requires digital solutions. Meanwhile, potential vaccines and drug therapies to treat the disease will come from the pharma and biotech industries. Finally, with the market concerned about the recovery, long term interest rates have fallen sharply, leaving 30-year real interest rates at all time lows. This is a familiar refrain of the past 10 years. Lower growth expectations and real interest rates drive higher valuations for growth stocks. Our view is that many of these benefits in the near term may prove to be fleeting if the economy continues to recover. In fact, second quarter earnings season, which begins this week, may lead to some disappointment for stocks that have done exceptionally well over the past month. Software, in particular, looks vulnerable to us. A related risk is that 30-year real rates start to move higher.
In addition to the rise in COVID cases, the markets are also growing wary of a potential Democratic sweep in the upcoming U.S. elections. Such an outcome is believed to be a risk to corporates and therefore the equity markets. My view is that it's way too early to call the election at this point, and it's not clear that Democrats are necessarily bad for stocks, at least historically speaking. On the other hand, a more clear and present political risk for investors is the fiscal stimulus bill that still needs to be finalized later this month. While we expect the two sides to come together and get it done, it's a very tight timeline that includes a hard expiration date on the supplemental unemployment benefits that have been critical to the recovery so far. Without an extension of these benefits and additional help to the states and local municipalities, the economic recovery will be at great risk.
The bottom line for us is that while no two recessions and recoveries are exactly alike, they all include periods of doubt and uncertainty. In the current case, that period began in early June and it could persist through the end of the month and into early August as we go through earnings season and await Congress's action on fiscal stimulus and whether or not we can get new cases of COVID under control.
Given our conviction for the recovery to continue, we suggest being patient with your money and take advantage of the opportunity to put that money to work in the more economically sensitive parts of the equity market as we deal with these lingering worries.
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