In its latest market outlook, LPL Financial says downside risk remains and points to three main factors behind that risk: elevated stock market valuations, Federal Reserve Chairman Jerome Powell’s pessimistic outlook for the economy and the markets, and rising tensions between the United States and China.
LPL also says investors are increasingly skeptical about a smooth, V-shaped recovery and that stocks could fall further, despite that fact they have rallied more than 30% from their March 23 lows. LPL says it is common to see 10% corrections after big rallies from major bear market lows.
Companies are cutting their earnings expectations dramatically, LPL says. The firm says the forward price-to-earnings (P/E) multiple for the S&P 500 Index, which covers the next 12 months has eclipsed 20, which is overvalued based on historical averages. In fact, it is at its highest level since the dot-com bubble in the late 1990s.
However, these fears may prove to be exaggerated if there is a steady earnings recovery beginning later this year, which LPL says it expects to happen.
“So while we acknowledge valuations are high relative to historical trends and a larger pullback would not surprise us over the near term, the market’s forward P/E ratio using depressed 2020 earnings doesn’t worry us too much, given the environment,” LPL says in its outlook.
Because the economy is contracting sharply, more fiscal policy support from Congress may be needed, LPL says. Powell had asked Congress to consider implementing more relief measures.
“We think markets generally have already priced in a historically sharp—but short-lived—economic contraction, even though along the road to recovery there may be some bumps that bring periodic bouts of market volatility,” LPL says in the report.
LPL says it may be possible that President Donald Trump thinks taking a tough approach with China will win him votes in November. If he takes this approach, the firm says, it could cause more market volatility. “Markets might get jittery if it looks like the United States may pull out of the trade deal signed with China in January,” LPL says.
On an optimistic note, LPL says it is encouraged by progress made so far in containing the coronavirus, signs that the U.S. economy starting to open up and the massive federal relief package that has provided “stocks with a tailwind that may get stronger in the coming weeks, along with another stimulus package potentially on the way.”
Considering all this, LPL is recommending “overweight equities in the intermediate-term period, especially in the context of dampened return prospects for bonds at such low interest rates.”
In its second quarter 2020 investment outlook, Kingswood tends to agree with many of LPL’s premises.
“The global economic downturn is of unprecedented severity—but the policy stimulus unleased is equally unparalleled,” Kingswood says in its report. “Economic activity should recover now that lockdowns are being relaxed, but a return to normality is unlikely for some time.”
Kingswood also says equities are likely to fall back in the short run because of steep equity valuations. Longer term, once the economy begins to reignite, the firm says it is more positive on equities as they “usually see substantial gains in the early stages of a bull market.”
Kingswood is retaining a “sizeable exposure to thematic equities, including technology and environmental change.” As far as bonds are concerned, Kingswood is bullish on corporate bonds but bearish on government bonds.
“The policy stimulus will be crucial in preventing major lasting damage to the economies,” Kingswood says in its outlook. “Even so, it is far from clear how strong the rebound will be. Most obviously, it will depend critically on how quickly and sustainably the lockdowns can be eased.”
Because a vaccine is unlikely to be developed until 2021 at the earliest, Kingswood says, social distancing of some kind is likely to be a fact of life for at least a year. As a result, travel and hospitality are unlikely to return to pre-coronavirus levels anytime soon.
Like LPL, Kingswood is worried about a return to a U.S.-China trade war, which would put a damper on growth.
“All this leaves us skeptical that there will be a sharp V-shaped recovery in the global economy,” Kingswood says. “We think it is unlikely that economic activity will return to pre-COVID-19 levels until the end of next year, with a risk that it could take longer still.”