August 13, 2020—The stock market has crossed another critical threshold on Wednesday, with the S&P 500 breaching the prior all-time high on an intraday basis. While we think the market momentum is likely to continue, we maintain a somewhat cautious stance going forward.

U.S. equities have recovered their pandemic losses on a surge of optimism around vaccines, monetary and fiscal stimulus, and a V-shaped recovery. The pillars holding up the market are real, but some are more structurally sound than others. The Federal Reserve’s liquidity support is not going away anytime soon, and vaccine progress continues to move at a rapid pace. What appears to be on shakier ground is the outlook for the consumer. The jobless rate is still at historic levels with the labor market showing signs of stalling, and there is little evidence of consumer demand returning to pre-pandemic patterns anytime soon. (TSA traffic is one example, having improved in recent weeks but still sitting at -70% y/y.) Consumer debt has come down and retail sales have somewhat miraculously returned to February levels, but the consumer remains uncomfortably reliant on the continuation of fiscal stimulus in the form of unemployment benefits and direct checks. Congressional debates on further relief measures are at a standstill. While we continue to believe a deal in Washington will eventually get done, the risk of the consumer falling off a “fiscal cliff” does not appear to be priced into markets.

Core narrative

We continue to be cautious on the market, given what we see as three key underpriced risks in the markets: 1) stalling or rolling back of economic reopenings associated with school starting in the U.S., 2) small business bankruptcies and a plateau of the labor market, and 3) the U.S. presidential election. However, waiting for an equity correction is not a viable investment strategy, particularly when the yield on a 10-year Treasury is approximately 0.65% and there are few alternatives for investors seeking a reasonable total return in their portfolios. As a result, we continue to take a cautious but not overly defensive stance in portfolios, with our exposure to equities slightly less than our strategic benchmarks, a modest overweight position to fixed income, and a newly established allocation to gold. Within equities, diversification is key. We expect some near-term bumps in the economy will lead to outperformance of growth-oriented equities, but an exposure to higher-quality cyclical stocks is important given how strongly these stocks could bounce should data surprise to the upside. I discussed these and other market-related issues recently on CNBC: Watch now.  

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