Why are U.S. stocks flirting with record highs amid a global pandemic?
On the latest edition of Market Week in Review, Quantitative Investment Strategist Dr. Kara Ng and Research Analyst Laura Bardewyck discussed the S&P 500® Index's recent flirtation with record highs, the current state of fiscal stimulus discussions in the U.S. and rising tensions between China and the U.S.
U.S. equities churn higher as market rally continues
Despite the ongoing global pandemic, the S&P 500® Index came close to establishing a new record high on 12 August, closing just six points below its 19 February record of 3,386. While this may seem counterintuitive, Ng said that the rally in equities is being primarily driven by cyclical tailwinds that are outside of recent news events. "Broadly speaking, fiscal and monetary support is massive - and that's very important for equity markets right now," she stated.
In addition, Ng pointed out that the coronavirus-induced recession means that the U.S. economy has large amounts of spare capacity. This, in turn, allows for a long runway of non-inflationary growth with low interest rates, she explained. "While there is still debate over the exact speed and magnitude of the nation's economic recovery, consensus expectations are that corporate earnings and economic data will directionally move up over the second half of 2020," Ng said.
She also noted that as markets continue their upward climb, some pockets of euphoric sentiment are starting to emerge. Ng cautioned that if such optimism continues to increase, equity markets may become overbought. "When risk-on assets reach this level, they can exhibit a disproportionate reaction to negative news - meaning they're more vulnerable to a selloff," she explained. For instance, news of a setback in China-U.S. trade relations or waning support for fiscal stimulus could serve as potential catalysts for a market selloff down the line, Ng noted.
Is a second U.S. stimulus package critical to sustaining the economic recovery?
Zeroing in on the latest developments regarding an additional coronavirus stimulus package in the U.S., Ng said that talks between Democratic and Republican party leaders in Congress have stalled. "Congress is now in recess until September, with no constructive meetings scheduled before Labour Day," she stated. While both parties agree on the need to provide additional relief for businesses and consumers, they remain at odds over the magnitude of proposed aid, Ng noted, with Democrats seeking $3 trillion in COVID-19 relief, while Republicans favour a $1 trillion package.
With the two sides at an impasse, President Donald Trump issued several executive orders recently that seek to continue coronavirus aid, including one that would extend enhanced unemployment benefits at a rate of $400 per week. Other orders direct the U.S. government to defer payroll taxes and student loan repayments, and to prevent evictions. In Ng's opinion, these actions may help a little, but they are not nearly enough to prevent the U.S. from reaching a fiscal cliff.
"The massive stimulus package passed in March was the primary driver of the nation's initial economic and market recovery. The recent presidential orders are not enough to keep this recovery going. Congress needs to pass a second stimulus bill to sustain the recovery," Ng stated. She noted that while household income typically falls during recessions, U.S. disposable personal income actually rose in the spring, as the CARES Act helped to insulate consumers from the plunge in economic activity.
Ultimately, Ng and the team of Russell Investments strategists expect that Congress will eventually come to an agreement on an additional stimulus package - between the $1 and $3 trillion range. "An amount somewhere in the middle will still provide massive support for consumers and businesses," she said.
China-U.S. tensions on the rise
Shifting to China-U.S. relations, Ng said that leaders from the two countries are set to review the Phase 1 trade deal signed in January soon. The expected meeting comes in the wake of rising tensions between Washington and Beijing over the U.S.' announced ban on social-media apps TikTok and WeChat.
"In recent days, several prominent U.S. companies have voiced their concerns over the ban - scheduled to take effect 20 September - stating that it will put them at a severe disadvantage when it comes to doing business in China," Ng said.
While the ban is an indication that tensions between the two nations may not be subsiding anytime soon, she doesn't expect a re-escalation of last year's trade war. In addition, Ng believes that the upcoming trade meeting between the two nations will probably be uncontroversial - likely just a tail risk worth keeping an eye on, she remarked.