Stocks struggled for a third consecutive week as investors continued to unload growth and tech shares. News during Friday’s trading session that the U.S. government would block all TikTok and WeChat downloads put additional pressure on already muted sentiment. In contrast, value stocks have recently benefited on a relative basis from the rotation out of momentum and into the more economically sensitive names. They were boosted once again on Wednesday by the Federal Reserve’s announcement that it intends to keep interest rates at 0% through at least 2023. The announcement comes in response to softening data in recent weeks that has evoked a longer-term accommodative stance by the Fed in order to keep the economy from backsliding. Separately, August’s retail sales figures were released this week. While the report showed some weakening relative to previous readings, consumers still managed to increase their spending for the fourth consecutive month. Overall, the market was uninspired this week, resulting in the S&P 500 falling -0.64%.
Zero Rates for Years to Come
The Federal Reserve made its future plans explicitly known following this week’s FOMC meeting, announcing it intends to keep interest rates low through at least 2023. The move was intended to send a strong signal to markets and let investors know that it intends to provide the necessary monetary support so long as the coronavirus-induced hangover remains. The central bank now projects the U.S. economy will contract -3.70% for the year (2020). This is actually quite an improvement relative to its -6.50% GDP forecast in June. While the major components of the recovery – including the monetary, fiscal, and private industries’ response – have all worked admirably to avoid worst case scenarios, considerable damage was sustained that will take additional time to heal. Unemployment is expected to remain elevated through the year with the Fed forecasting that the unemployment rate will still be as high as 7.60% by year-end. Here again, this is an improvement relative to the 8.40% unemployment rate reported in August but nearly double the unemployment rate heading into the crisis.
Back-to-School Spending and Remote Workers Lift Retail Spending
Retail sales notched their fourth consecutive monthly gain with sales rising 0.60% in August. Although that is down from the 0.90% increase in July, it is still encouraging and comes despite the loss of enhanced unemployment benefits and elevated unemployment. Back to school spending boosted retail spending during the month as parents outfitted their children with new clothes and electronics. Remote workers also lifted sales, settling in for the long haul by continuing to buy up furniture to convert their homes into more work-friendly spaces. Grocery stores actually saw their sales fall -1.60% during the month, an indication that more and more people are leaving their homes and the coronavirus induced scarcity has passed. Even online merchants such as Amazon saw sales slow. Overall, August’s retail sales figures were encouraging by signaling consumers are still capable of spending even as government stimulus has waned.
While market sentiment this week may not have been very enthusiastic, quietly the dominant factor was the Fed’s announcement. Their announcement to keep rates low, coupled with the Fed’s previous statement that they are willing to let inflation rise without an immediate response, means that rates are unequivocally anchored to zero for the foreseeable future given the most plausible paths for the economy looking forward. It is a double-edged sword. On the one hand, low rates are good for economic and investment activity, providing investors with a degree of downside protection, but it also inflates and distorts asset valuations, requiring that investors reach and speculate for return. The market currently trades at a 21x PE. In normal times, this would be expensive but in a low interest rate/low inflation environment its entirely justifiable. For investors, this sets up a problem based on your investment horizon. Investment returns are negatively correlated with the P/E multiple at which you invest. If long term P/E’s tend to average closer to 16-18x, the fact that the market is trading at a 21x presently means that the future contains a headwind for investment returns. This headwind can be overcome so long as the future growth on earning exceeds the dampening effect of those earnings being valued at a lower multiple. This is the reason why growth stocks carry a high multiple, but when we’re talking about a market as a whole – the U.S. market in particular that has a sustainable growth rate of 2-3% – the consequence is that investors may just have to accept lower future returns. The conundrum for investors today is that the Fed and the market has inflated asset valuations to a justifiable level based on current monetary policy, but to a level that is high historically. Should rates ultimately normalize, so too should multiples. This, in turn, should place a headwind against future returns. This all makes the Fed’s announcement this week bittersweet – its undoubtedly good for investors in the near term with a price to be collected later.