In a year in which COVID-19 has devastated the U.S. economy, the SPDR S&P 500 ETF Trust (NYSE:SPY) is now down just 2.5% year-to-date in the first half of the year.
While investors are thankful for the resiliency of the stock market, Brad McMillan, Chief Investment Officer for Commonwealth Financial Network, recently said the disconnect between stock prices and the underlying economy will likely weigh on stock prices in the second half of 2020.
In his midyear outlook report, McMillan said there are still so many unknowns about COVID-19 and the fallout from the outbreak that it’s extremely difficult to make reliable long-term predictions at this point. However, even if investors completely write off the first half of the year and the economy begins to grow again starting in the third quarter, the path higher for stocks may be a steep one.
For now, McMillan says investors should focus their attention on three critical areas heading into the second half of the year: inflation, interest rates, U.S. equity markets and international equity markets.
McMillan projects inflation levels will likely remain depressed throughout the end of 2020 due to fallout from the demand shock the economy experienced in the first half of the year. At the same time, he said interest rates across the yield curve will likely remain low given the stagnant inflationary environment.
Earnings Are Key: As a result, McMillan predicts earnings numbers will constrain U.S. stock market returns for at least the next two quarters. Given the steep decline in corporate earnings in the first half of the year and the only modest year-to-date drop in the S&P 500, McMillan said U.S. stocks are currently priced as if 2021 earnings will be mostly in-line with 2019 earnings.
“If the economy and corporate earnings are at the same level as 2019, then it is hard to justify meaningful appreciation above that level. Stocks are likely to end 2020 at or close to current levels—around 3,200 for the S&P 500 and 27,000 for the Dow—even assuming the pandemic remains under control and the recovery continues without significant setbacks,” McMillan said.
He also sees the same valuation constraints in international markets as well and predicts little upside to current levels for major international markets in the second half of 2020.
McMillan said the biggest upside risk to his outlook would be widespread availability of a COVID-19 treatment or vaccine in the near-term, but the science and scalability requirements suggest that outcome is not likely. To the downside, McMillan said a sizable second wave of US outbreaks and another potential lockdown looks far more likely in the near-term than a potential large-scale vaccine.
Benzinga’s Take: McMillan’s year-end S&P 500 target of 3,200 suggests just 1.7% upside for SPY investors over the next six months. While that return may seem disappointing, investors should remember that the idea that the S&P 500 would finish 2020 down less than 1% for the year would have seemed unrealistically optimistic just three months ago.
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