How Is the Economic Outlook Affecting the Stock Market?
Posted by: Doug Gerlach 12/15/2020 3:32:26 PM

In the December 2020 Investor Advisory Service, our analysts addressed the pandemic economy and its impact on the stock market.

U.S. economic growth is rebounding following the near-shutdown induced by the COVID pandemic. Third quarter Gross Domestic Product rose at an annualized rate of 33.1%, recovering three-quarters of the second quarter’s decline. Further growth into the fourth quarter is likely, although regional restrictions resulting from rising COVID cases will probably temper growth. Overall, though, most indicators point to an economy that is still about 5% smaller than before the pandemic.

 
The unemployment rate fell to 6.9% in October from a high of 14.7% in the Spring. Retail sales remain strong, although cracks are starting to appear following the resurgence of COVID in October. Industrial production is returning as factories struggle to keep up with demand, especially following supply chain problems, as production restarted at an uneven pace. Shortages of many products have been reported, including toilet paper, cars, and even paint. Lower consumption of services like travel and dining out explains all the decline in the U.S. economy from pre-pandemic levels even as consumption of goods is at an all-time high.
 
The first thing we think of when we hear the word “shortages” is “inflation.” Shortages give pricing power to producers. However, inflation has been surprisingly tame, rising just 1.2% year-over-year in October, or 1.6% excluding the volatile food and energy sectors.
 
Europe experienced even stronger growth than the U.S. in the third quarter. It was hit harder by the pandemic in the spring and experienced an even sharper fall in output. A resurgence of the virus and accompanying economic shutdowns point to negative growth in the fourth quarter for Europe.
 
Due to greater experience with past viral outbreaks and cooperative citizens, the economic impact on Asia has been much more muted. China actually returned to year-over-year growth in the third quarter while many other Asian countries have experienced only moderate contractions.
 
All three major U.S. stock market indices reached new all-time highs in November. The primary catalyst has been success producing vaccines to prevent COVID-19. So far, two vaccines have shown 95% effectiveness without significant side effects. There are at least four other vaccine candidates under development by leading pharmaceuticals firms. The U.S. government has pre-bought 100 million doses from each firm, providing the six candidates with approximately $10 billion to fund research and development and to begin manufacturing product before even knowing whether their vaccines will be successful. However, having access to product right away upon approval leads experts to believe most Americans can look forward to receiving a vaccine within the next six months. The market has been encouraged, as should we all, to see light at the end of the tunnel.
 
Stock valuations are somewhat stretched as low interest rates and a flood of government money have pushed investors into stocks even as corporate earnings are down in many cases. Still, there are pockets of opportunity even though one must search harder than in the past to find them. We continue to believe the stock market can produce much better risk-adjusted returns than a 10-year Treasury bond still yielding less than 1%.


Reprinted from the December 2020 issue of the Investor Advisory Service.