Midyear Outlook: Getting to the “New Normal”

THE FIRST FEW MONTHS OF 2020 were unlike anything we’ve ever experienced. Uncertainty surrounding the coronavirus outbreak triggered the fastest and sharpest decline in the stock market on record and pushed the U.S. economy into its first recession in more than a decade, with millions of Americans out of work. But by early June, the stock market had recovered much of its losses from the bottom on March 23, and key parts of the economy had already begun to show signs of improvement. 

In this Q&A, Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank, shares his perspectives on what the tumultuous first half of 2020 has taught us, where the economy and markets may be headed next, and ways investors can prepare for a new normal when much of life could look very different.

For a more detailed look at what the rest of the year could bring, please read Investment Strategy Overview.

Q: What are the prospects for economic recovery in the months ahead?
A:  It’s early, but we’re seeing remarkable signs of resiliency across broad areas of the economy and expect quick but fragile “V-shaped” recoveries—or fairly quick and sustained initial rebounds—following the steep drop in economic activity earlier this year. Manufacturing, housing and even auto sales have turned upward to varying degrees. Consumers, the engine of the U.S. economy, are spending more than they were in late March and April, thanks to unprecedented government stimulus and central bank liquidity programs. Even with widespread job losses, disposable personal income is actually rising as a percentage of overall expenses. Yet everything hinges on an end to the health crisis. And we’ll be looking for improvement in the most critically harmed industries, such as travel, leisure and entertainment.

Q: What other signs are you watching for that could tell us the recovery is gaining momentum?
A: A key area we’re watching is corporate earnings—and how quickly earnings are recovering, profits are recovering. Right now, the market is looking at both stimulus spending and actions by the Federal Reserve (Fed), but once we get closer to the election and into next year, earnings and profitability will ultimately be what matter most.

Another indicator we’re watching closely is the yield curve (which shows the relationship between the interest rates of bonds and their time to maturity).  The fact that the yield curve is now steeper relative to where it was before the virus is a sign that the steps the Fed is taking are helping stimulate growth; it’s telling us that we’re in the midst of a cyclical recovery.  This, together with the dollar showing some signs of weakness (or at least a peak in its strengthening) are helping create the initial workings of an economic expansion.

Q: Is the government stimulus over, or could there be more to come?
A: We expect another round of fiscal stimulus sometime before the end of July, with aid for state and local economies and funding for hospitals. Depending on what the unemployment figures look like, there may be further relief there. On the monetary policy front, the Fed has said it will provide whatever liquidity is needed to support a longer lasting recovery.

Q: What do you see as the top risks through the end of 2020?
A: The biggest risk in our view is a second wave of the virus, which, in addition to the health consequences, could bring on another bout of sharp volatility. Unlike March, when the Chicago Board Options Exchange Volatility Index (VIX) hit a record of over 80, we’ll likely see short-lived “mini spikes” in the VIX if and when regional virus outbreaks occur, as we’ve seen in the southwestern United States and Florida. If hospitalizations and ICU cases begin to escalate, markets could react negatively. We’ll be watching carefully in the weeks and months ahead. Other events that could affect the markets include the November elections and the possibility of increased tensions between the U.S. and China.

Q: How could this year’s election affect the markets?
A: Elections typically bring what markets dislike most: uncertainty. Regardless of the year or who’s in the White House, potential changes in the presidency or Congress always move some investors to the sidelines and slow down equity flows in the lead-up to Election Day, and volatility usually picks up. This year, because of the pandemic, the shutdown and a potential fragile recovery, the election brings even greater uncertainty and potential volatility. The market’s biggest concern is what a clean sweep of the White House and Congress by either party might mean in terms of tax policy, regulation and trade.

Q: How long could interest rates stay at such low levels, and what does that mean for both borrowers and investors?
A:  The Fed has indicated it will keep the federal funds rate (a key short-term interest rate) close to zero through 2022—which could be good news for borrowers. The Fed will be focused on maintaining both interest rates and kick-starting “effective” inflation at levels that support the broader recovery and could take other actions—such as buying long-term bonds— to help engineer recovery over several years. All of which means people who look to bonds for income shouldn’t expect higher rates any time soon. Bonds still remain an important part of portfolios, but we recommend being overweight to equities to help generate income as well as growth.

Q: On that note, what do you see as the most promising areas for equities that investors could consider?
A: Healthcare and technology are keys to getting us through the pandemic and into full recovery. We also see opportunities in companies supporting the move to “e-everything”—from learning to gaming to sports. That trend is likely to continue even after the virus is behind us. Other promising areas for equities include consumer discretionary and the industrial sector, which looks especially interesting because of all the reconfigurations related to trade and supply chains and new processes in 3D manufacturing, robotics, automation and hygiene. Another key opportunity coming out of this pandemic will be industries and companies that focus on sustainability, such as social, environmental and governance (ESG) factors.

Q: Tell us more about what you mean by sustainability.
A: Even before the pandemic, we identified global social and environmental challenges as a key investment theme for the 2020s. In light of the health crisis, there’ll be an even greater focus on health, renewable energy, clean water and sanitation and other industries supporting a more sustainable future. Sustainability means other things, too. A year of pandemic, combined with the growing movement for racial justice, is prompting companies to reexamine their practices in a number of areas. They’re asking not just how they can better prepare for future disruptions, but how they can grow responsibly and support a better society for everyone. That translates into opportunity for investors, given the growing body of data suggesting that companies with stronger ESG records tend to be stronger financially.

Q: Considering everything we’ve been through in the first half of 2020, is there any final guidance you could share with our readers?
A: First, it’s important to consider whether your goals or priorities have changed based on what we’ve been through. If so, it’s a good idea to meet with your advisor to review both your investment strategy and asset allocation and make any appropriate adjustments that might be needed. Now is also a good time to consider taxes, and whether there are ways to potentially improve overall tax efficiency in your portfolio, given the volatility.  Finally, try to take emotion out of the equation, be disciplined and stay focused on what you want to achieve over the long term.