B. Riley Advisor Talking Points: Buckle Up For A Choppy Market—It’s Just Politics!
Year-to-date, the S&P 500 Index is up 2.09%, and for the past year, it is now up 10.51%. The tech-heavy NASDAQ Index is up year-to-date 21.63%, and it is currently up 35.11% for the past year.
The Economy Is Starting To Slow & The Stock Market Is Still Overvalued
For over six weeks in these Market Commentaries, I have been warning that the U.S. stock market was overvalued by almost all traditional measures.
Also, parts of the economy are starting to slow, especially employment growth. Recent data and trends show how difficult it will be to create significant numbers of new jobs if we can’t fully reopen the economy. We are continuing to see solid gains in manufacturing and services, but these industries will not wholly offset the unemployment in other sectors.
According to Factset, the forward 12-month Price Earnings Ratio (P/E) for the S&P 500 Index was 21.7 as of Friday. That means the S&P 500 Index could be overvalued by more than 17% compared to the 5-year forward P/E average of 17.2.
I have warned that investors should not be surprised to see a 10% or more pullback or correction from current prices over the next few months. This would be the start of a normal, healthy reversion to the stock market’s long-term trend of a forward 17 P/E ratio.
That doesn’t mean we won’t see more declines and volatility before and possibly after the election—we likely will—but because the stock market is overvalued, such a pullback will be an entirely normal and healthy correction. Sometimes the markets get ahead of themselves, and then they adjust. That is what is happening now.
S&P 500 & NASDAQ Indexes Continue Their Pullback
This past week, the S&P 500 Index and the NASDAQ Index continued to pullback from their recent record highs.
As we take a look at the current state of the overall underlying U.S. economy, we can see from this week’s ECRI Weekly Leading Index of leading economic indicators that the economy is still growing and expanding—but at a slightly slower rate.
First The Good News—The Recession Is Over
We may not get an official ending date for the recession from the National Bureau of Economic Research (NBER) for months, but most Wall Street analysts agree that the recession is now over.
U.S. economic activity fell more in the second quarter of this year than during any other period in U.S. history. The good news is that it will also grow faster in the third quarter of this year than during any other quarter in history. New economic forecasts show sustained economic growth through 2021 and beyond. That is the best news long-term investors can have if they stay invested in the stock market.
Unfortunately, the Coronavirus crisis is still with us, with over 5,000 Americans dying every week, and over 200,000 confirmed dead in the U.S., and another 1 million worldwide. Parts of the economy are still in desperate straights since the government cut off almost all of their stimulus spending, and there are still 26 million Americans on the unemployment rolls. Also, entire industries have come to a halt, and economic output is hundreds of billions of dollars below its pre-pandemic levels.
Amazingly, this has not dampened the pace of overall economic growth, which is still expanding and growing. Retail sales, manufacturing, housing, and many services have now rebounded to pre-pandemic levels.
The Federal Reserve last week released an optimistic forecast for how the economy was going to fare this year.
The Fed projected the U.S. would end the year with unemployment at 7.6% and saw the economy only shrinking by -3.7%. Most analysts thought the economic damage would be far more significant, even though it is still terrible for workers out of a job and businesses fighting for survival.
Where Do We Go From Here?
The stock market hates uncertainty, so investors will undoubtedly see volatility in the short term until the presidential election is finally resolved.
Over the longer term, here are the main open issues that need to be resolved before the stock market and the economy can get back to some semblance of normal.
- A second wave of Covid-19 infections over the winter months and the effect on the economy.
- When will we have a verified, safe, and effective vaccine for Covid-19?
- A foreign policy crisis: U.S.-China relations, Russia, Iran, or North Korea.
The good news is that one of the first things economists learn in “Economics 101” is that the U.S. stock market always follows the directional trend of the underlying U.S. economy over the long term. If the U.S. economy is growing and expanding, the U.S. stock market will go up in the long term. If the U.S. economy is plateauing or going sideways, the U.S. stock market will go sideways in the long term. And, if the U.S. economy is contracting and declining, the stock market, in the long term, will decline with it.
Right now, the underlying U.S. economy is continuing to grow and expand, and more importantly, is expected to accelerate that growth through 2021-2022—especially if, as expected, we finally get a safe and effective vaccine sometime early next year.
How Should An Investor React?
Stay invested in the stock market! If you looked at the historical stock market performance charts when there were similar fears over the SARS virus and the MERS virus, they were all short-lived, and investors were rewarded for staying in the stock market.
The same will happen no matter who wins the election. In modern times, there has never been a correction (defined as a 10% drop in the market) after a presidential election− not even after President Obama’s election win during the height of the 2008-2009 recession.
Despite this current market pullback, the U.S. economy is still growing and expanding.
Once the stock market returns to a more reasonable valuation, it can resume its growth in a more sustainable valuation.
As the great investor Warren Buffett has said, “Patience is always the friend of the investor.”
NOTE: This report is authorized for distribution to clients
Paul Dietrich, Chief Investment Strategist, B. Riley Wealth Management
Paul Dietrich is focused on managing investments for private investors, retirement funds, and private institutions throughout the United States. He also serves as a frequent on-air commentator. He regularly contributes market analysis to business and financial media, including CNBC, Fox Business, Bloomberg TV, CNN, The Wall Street Journal, Yahoo! Finance, Reuters, and The Washington Post.
Information and opinions herein are for general use; are not unbiased/impartial; are current at the publication date, subject to change; may be from third parties, and may not be accurate or complete. Past performance is not indicative of future results. This is not a research report or solicitation or recommendation to buy/sell any securities. B. Riley Wealth Management is not engaged in rendering legal, accounting, or tax preparation services. Opinions are the Author’s and do not necessarily reflect those of B. Riley Wealth Management or its affiliates. Investment factors are not fully addressed herein. For important disclosure information, please visit www.brileywealth.com/legal-disclosures.