Although there remains enormous uncertainty regarding the immediate future, it is important to remember that financial markets are forward looking and will anticipate an improvement in economic trends well in advance of the media.
Long-term investors should adjust asset allocation strategies to reflect an overvalued bond market and undervaluation in common stocks. The most important indicator of an expected shift in market psychology will be concrete evidence of a peak in the number of new COVID-19 cases.
In this edition of Economic Commentary, Robert F. DeLucia, CFA and Consulting Economist for MEMBERS Capital Advisors, Inc., provides a review of the U.S. economy and independent variables that investors should closely monitor. Here are the highlights:
- There are two central themes governing global financial markets: Investor panic and market illiquidity. All asset classes are under intense selling pressure as investors in all markets engage in a frantic scramble for liquidity.
- The general feeling among investors is that “cash is king.” There are even instances of sales of US Treasury bonds to buy Treasury bills, the quintessential risk-free asset.
- The US economy entered a recession in March, one that could persist throughout the second quarter. The depth and duration of the recession is impossible to predict, but will depend upon the success of containment measures designed to flatten the curve of new infections.
- Corporate earnings in both the first and second quarters will also suffer severe declines. Assuming the number of cases peaks later this spring, Q3 earnings could stabilize on a sequential quarter-to-quarter basis, followed by a sharp increase in Q4.
- Investors should also pay close attention to the other indicators, including continued policy support from central banks and fiscal authorities and the day-to-day functioning of money and credit markets.
- Other trends to monitor include the speed at which businesses are able to restart the economy. This includes routine data regarding airline bookings, office and retail store openings, and new hiring intentions.
- A close monitoring of economic recoveries in the early-infection countries — most notably China and South Korea — can provide relevant insights regarding the eventual US recovery.
- At current valuations, equity markets offer an exceptional buying opportunity for long-term investors. Annualized total returns for the S&P 500 could easily exceed 10% over a three-year time horizon. Expected annual returns for a diversified bond portfolio are unlikely to exceed 2.5%.
All opinions and commentaries expressed are those of the writer, Robert F. DeLucia, and do not necessarily reflect the opinions of CUNA Mutual Group, CBSI, or its management.
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