Risk Premium far better than 1999–2000
Market update: 2020-10-26.
Equity markets fell mildly last week with the S&P 500 slipping 0.5%. Ongoing bickering about a U.S. fiscal stimulus package, rising COVID cases across most of the world, and the up-coming Presidential election has us in the normal stall zone. Technology and consumer discretionary sectors pulled back. Banks added 3.2% on the week, but they are still down more than 30% in 2020.
Resilient equities
Many investors are puzzled by the resilience of equities in the face of the economic shock of the virus. However, our view is that stocks are doing what they should be doing, given that the worst impact is not in areas that trade on the stock market indexes. The continued weakness in banks partly reflects both the underperformance of small cap stocks as well their lag affects with an improving economy.
Equity risk premium
For those interested in the academics behind the markets, here is some information regarding the equity risk premium. The equity risk premium is calculated as the difference between the estimated real return on stocks and the return on safe Treasury bonds. That premium was just over 4% pre-COVID. While it widened sharply during the March correction, it has since narrowed to about 5%. The big swing factor is the risk-free rate/Treasury bond, which plunged and has yet to rise meaningfully thanks in part to central bank guidance.
We note that the risk premium today, based on this approach, is twice as wide as it was in the late-1990s. That period is often brought up as a concerning comparison given the recent strength in technology. On this metric, stocks are far from the bubble they were in the 1999–2000 internet bubble which is mentioned frequently on CNBC.
Economy
Positive economic news that will move to the back burner for the next two weeks. The final countdown to the election includes two major items.
U.S. leading indicators climbed 0.9% to 107.2 in September after jumping 1.4% to 106.5 in August. This is a fifth straight increase in the index after three straight declines from February through April. The index dropped -6.4% to 96.9 in April and was at a record high of 112.0 in July 2019.
On the manufacturing side, the IHS Markit PMI Output Index posted 55.5 at the start of the final quarter of 2020. This was up from 54.3 in September and signals the fastest increase in private sector business activity since February 2019. Additionally, service sector firms recorded a marked and accelerated rate of expansion in output.
Resources
- Our complete second half outlook has been also posted and can be found by clicking here.
Weekly market updates contain general information and expresses views of Oak Harvest Investment Services. Data, Articles, and information cited are believed to be reliable at the time of creation, but are not guaranteed. Nothing in this content is intended as, nor should it be regarded as, personalized investment advice. Strategies and ideas discussed may not be right for you. Views and opinions expressed may change without notice and do not constitute a recommendation, or an offer or solicitation to buy or sell securities. In addition, Oak Harvest makes no assurance as to the accuracy of any forecast made. Indexes like the S&P 500 are not available for direct investment and your results may differ. Past performance is not indicative of future results. Investing involves the risk of loss.
