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The U.S. economy remains challenged, but there are some encouraging signs, according to John Hancock Investment Management’s Q3 Market Intelligence Outlook, released Thursday.

“Leading economic indicators remain depressed but appear to be bottoming,” the firm said in the report.

Citing The Conference Board’s composite index of leading indicators as of May 31, John Hancock said: “Despite the sharp downturn in leading indicators in March and April, encouraging signs began to appear in May, with the majority of indicators turning up from very low levels.”

The index rose 2.8% in May, the most recent month for which data is available, following a 6.1% decline in April and a 7.5% decline in March.

Earnings Season Surprises in Store

The “earnings downturn isn’t uniform across sectors,” the report said, pointing to utilities and information technology stocks as the only two sectors expected to see year-over-year earnings per share growth for 2020, of 1.82% and 1.52%, respectively. Every other type of stock is expected to decline anywhere from 1.18% (health care) to a whopping 105.62% (energy). However, the firm is estimating each sector to see EPS growth in 2021.

“Earnings season may be full of surprises,” according to Matthew Miskin, co-chief investment strategist at John Hancock Investment Management and one of the report’s authors. “Lack of corporate guidance and clarity on the quarter makes analyst estimates of a 45% decline in S&P 500 Q2 earnings a best guess,” he told ThinkAdvisor on Friday.

Investors’ Best Opportunities

“Mid-cap stocks offer an attractive post-recession opportunity,” the report said, adding: “After the largest underperformance vs. the S&P 500 Index since 1998, U.S. mid-caps may bounce back coming out of this recessionary period.”

U.S. mid-caps “benefit from increased fiscal stimulus and have shown the ability to bounce back out of recessions,” according to John Hancock. “Since the market low in March, mid-cap stocks have been among the best performers across the cap spectrum,” it noted in the report.

Investment-grade corporate bonds, meanwhile, “offer an attractive risk/reward profile,” it said, adding: “Support from the Fed’s current bond-buying programs provides an additional tailwind.”

In fixed income, “emphasizing quality investment-grade corporate and government bonds may outpace lower-rated issues,” John Hancock said, noting it has a 12-18 month view of “neutral” for fixed income. “Returns on short duration fixed-income strategies are likely to remain low,” it predicted.

“On the fixed income side, we continue to prefer a modest credit bias to achieve better income then the paltry 1.2% of the Barclays US aggregate bond index and maximize the benefit of Fed support,” Miskin told ThinkAdvisor. “We are targeting A, BBB, and selective parts of BBs parts of the corporate bond credit spectrum,” he said, adding: “The Fed has only used a drop in a bucket this far relative to the $750 billion available in credit facilities. However, we do not believe that investors are getting compensated enough to be overweight high yield at these spread levels.”

In early 2019, the firm “upgraded our fixed-income view from slightly bearish to neutral, where it remains amid a challenging environment for global growth,” the report said. “In Q1, we increased quality further by upgrading U.S. Treasuries from neutral to slightly positive and further increasing our overweight in mortgage-backed securities,” it said, adding that in the third quarter that just started, “we’ve continued increasing quality by moving emerging-market debt to slightly negative from neutral.”

Cash, meanwhile, “can’t compete with investment-grade bonds as a long-term holding,” the report said.

The U.S. equity market “exhibits better fundamentals relative to non-U.S. equities, as measured by return on equity and sector composition,” the report said, adding:  “Embracing quality allows investors the chance to both participate and protect.”

The firm continues to “advocate tilting portfolios to the quality factor based on a challenging earnings backdrop,” Miskin told ThinkAdvisor. “Balance sheet strength and relatively insulated cash flows are two criteria we are focusing on.”

Election Outlook

The election is only “starting to get on investors’ radars, but November feels like a lifetime away given how impactful COVID-19 has been,” Miskin told ThinkAdvisor.

“Historically, market returns in years where there is an incumbent running for reelection have been better than an average election year,” he noted.

Meanwhile, “additional unemployment benefits are going to be coming off in a couple weeks,” he pointed out, warning: “Further fiscal support will likely be needed,” but predicted that will be “welcomed by the administration.” The economy overall “will likely need continued support in the second half of the year,” he said.

“As for after the election, reviewing market returns across presidential and Congress parties suggests no clear market winners or losers,” he went on to say, adding: “The underlying economic trends and starting point of the market (taking over office after a large decline is best) tend to be way more important to markets than the political parties represented in Washington.”

5 Other Highlights From John Hancock’s Outlook

  1. “Inflation will undershoot central banks’ targets for a sustained period, keeping both policy rates and government bond yields at very low levels.”
  1. The firm does not see a need to chase high-yield bonds. “Fed policy continues to keep credit markets neutral to slightly positive,” it said.
  1. “A weaker U.S. dollar will help lift commodity prices and more cyclical sectors of the stock market.”
  1. “Returns on short duration fixed-income strategies will remain low.”
  1. “The fed funds rate is back to zero, and forward guidance suggests that it will remain there until at least 2022.”

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