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Schwab’s Sonders: Second-Half Stock Market Outlook Is Cloudy

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This year more than ever, the outlook for the U.S. stocks in the second half is anyone’s guess. After hitting bottom on March 23, down 34% from a record high reached a month earlier, then recovering 95% of those losses by June 8, the S&P 500 remains mired in choppy trading.

Recently, strong retail sales boosted prices, but news of rising COVID-19 infections and hospitalizations in states that have aggressively eased restrictions tugged stocks in the  opposite direction.

“The warp speed nature of the pandemic and economic crisis helps explain the equally warp speed nature of the stock market’s behavior,” writes Liz Ann Sonders, chief investment strategist at Charles Schwab & Co. in her midyear outlook.

Sonders expects to get more clarity on the depth of the economic downturn when second-quarter earnings season begins early next month and the second-quarter GDP report is released near the end of July.

“Second quarter earnings season may be an eye-opener — not just what’s reported for earnings in the quarter but what companies say about the second half outlooks,” writes Sonders. About one-third of companies in the S&P 500 have stopped providing earnings per share guidance this year because of the pandemic.

In the meantime, the outlook for the second quarter is dire. The Atlantic Fed’s GDPNow forecasting model estimates a 45.5% annualized decline in second-quarter GDP; Wall Street forecasters see a 20% to 40% decline.

(Related: U.S. Recession Began in February: NBER)

“This is not a normal recession,” writes Sonders. She explains that in normal recessions, as government debt rises, private-sector debt declines but that hasn’t been the case this year. Both are rising, with non-financial corporate debt, already at a record high before the pandemic, continuing to grow.

The Shape of the Recovery

Also, the V-shaped recovery that has followed many previous recessions and which many market analysts and economists had been predicting, is more likely to look like “rolling Ws” — up, down and repeat, according to Sonders. “The stock market probably got a bit ahead of itself in pricing in a V-shaped recovery.” Sonders doesn’t provide year-end targets for stock index levels or EPS forecasts.

Wells Fargo does, and its analysts are forecasting that S&P 500 EPS will decline 30% to $115 in 2020 and the index will ends the year near 3,250, about 100 points from its current level. 

“We believe worldwide reopenings, improving economic data and bullish investor sentiment support further 2020 gains,” Wells Fargo analysts write in the firm’s midyear outlook report. But they caution that “ongoing uncertainty surrounding the pandemic and the November elections” remain and could affect stock prices.

Wells Fargo analysts recommend that stock investors buy quality, favoring U.S. equities over international stocks and large- and mid-cap stocks over small caps. “This remains the appropriate positioning given economic and earnings uncertainty, limited upside to our 2020 year-end targets and our expectations for the U.S. economy to lead the global recovery.”

Morgan Stanley has a very different view of which stocks to own now. ”Late cycle high quality stocks remain richly valued and are likely to re-rate lower as interest rates rise at the backend,” writes analyst Mike Wilson in the firm’s midyear outlook. He favors small-caps over large-caps and cyclicals over defensive names within a scenario that expects a V-shaped recovery. 

Wilson doesn’t expect there will be another lockdown of the economy even if a second wave of COVID-19 hits “because it’s too damaging” and we are better prepared to deal with the outbreaks given wider testing and health care capabilities.

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