As I suggested last quarter, the market has responded positively to a better understanding of Covid-19 and how to treat it. Political polarization, on the other hand, is likely to only increase into the election this fall. Social unrest is a problem, but rioting has given way to more rational discussions of legitimate issues.
Despite the upheaval, the S&P 500 is only -4.04% YTD, and that is from a level that might be considered 5% overvalued by the Morningstar indicator.
In terms of the Morningstar market valuation indicator, the market ranged from 78% of fair value on April 1, to 5% overvalued on June 8. We finished the quarter 1% undervalued. Recovery has been driven by Government stimulus, business reopening, progress in controlling the virus, and hope for a vaccine. As we open the 3rd quarter, only the Government stimulus remains as a tailwind.
Near term, the market does not seem to have a lot of upside until we have a Covid-19 vaccine. The market anticipates a vaccine by early 2021. Although the market may pop on headline vaccine news, a development that could cause a sustainable rally is likely to me months off. Beyond that, we need to reckon with the 600-pound gorilla at the end of the vaccine tunnel: the election. While most administrations take more credit than they deserve regarding market movements, the current polarization could have a major adverse impact if the Democrats win both the Presidency and the Senate, opening the door to a progressive tax, spending, and anti-business policy in general.
So which direction do I think the market will move next? Last quarter I suggested, “we should see better than average returns in the not-too-distant future.” Now, however, I am less inclined to speculate about the short-term given the range of possibilities and the lack of near-term earnings visibility. Longer-term, the trend is still up. Earnings are almost certain to improve as business and employment normalize post-pandemic. The real question surrounds the rate of growth.