3 key risks for markets in the second half of the year

by Abraham Robison, Russell Investments

On the latest edition of Market Week in Review, Senior Quantitative Research Analyst Abraham Robison and Research Analyst Brian Yadao discussed the latest government responses to the coronavirus pandemic. They also spoke about the main risks for markets over the next several months and provided an update on the global economic outlook.

UK unveils additional stimulus package

The week of July 6 was active on the policy front, Robison said, as governments from around the world continued to take further steps to combat the impacts of the coronavirus. The UK, for instance, announced an additional £30 billion stimulus package on July 8, he noted, to help rejuvenate the nation’s economy. Meanwhile, with COVID-19 infections surging in parts of the world, some nations reinstated partial lockdowns, such as Australia, Robison said.

“All in all, recent weeks have been comprised of a mix of economic fits and starts, as governments grapple both with containing the virus and reopening their economies further,” he concluded.

How could the U.S. November elections impact markets?

The ongoing uncertainty surrounding the path of the coronavirus, the vast amounts of fiscal stimulus pumped into the economy in response to the virus and the upcoming U.S. elections all present risks for markets over the next few months, Robison said.

“Some investors are beginning to worry about an increase in inflation, due to all of the stimulus we’ve seen since March,” he stated. However, Robison said that so far, inflation remains low, adding that he believes it won’t be a problem until at least 2022. “There’s still an output gap in the economy, which is disinflationary in the short-term,” he explained.

Turning to the U.S. November elections, Robison said that a negative risk for markets would be a re-escalation in trade tensions with China by the U.S., as part of a potential re-election strategy for U.S. President Donald Trump. A win by presumptive Democratic presidential nominee Joe Biden, coupled with a Democratic Party takeover of Congress, also would present some risks, he said. “Some of the 2017 corporate tax cuts could be unwound, and there may also be a push to regulate the technology sector more,” Robison noted.

At around the same time of the year, the Northern Hemisphere will enter cold and flu season, which has led to worries over a larger, second wave of the coronavirus. However, Robison pointed out that it’s still unclear what role seasonality may play in the spread of the virus.

What could spark a market rally?

On a brighter note, there are also several potential developments that could lead to a broader rally in markets, Robison said. The biggest one would be the news of a vaccine for the coronavirus, he noted, explaining that markets would likely be quick to react in a positive way.

Another upside would be if more countries around the world are able to bring the virus under better control, he stated. “China is a good example of this,” Robison remarked, “as its economic output, measured by GDP (gross domestic product), is now close to pre-COVID-19 levels.” This has led to the recent strong rally in Chinese stocks, he noted.

By contrast, Robison said that the U.S. economy has only recovered about halfway—although there have been some recent encouraging signs. “Durable goods orders were pretty strong during May, which is a big positive, and the Institute for Supply Management (ISM)’s non-manufacturing index for June also came in way above expectations,” he stated.

The Job Openings and Labor Turnover Survey (JOLTS) also topped consensus forecasts, Robison said, with the U.S. government reporting approximately 5.4 million job openings in May. In addition, weekly jobless claims—although still very high—are continuing to trend downward, he added.

“From a glass-half-full viewpoint, if the U.S. is able to get a better handle on the virus, we could see jobless claims fall further, leading to a market rally,” Robison observed.

Global economic outlook

Assessing the overall economic outlook for the globe through Russell Investments’ three core pillars of investing—cycle, valuation and sentiment—Robison said that sentiment is currently mixed. “There are pockets of optimism and pockets of pessimism, so it’s essentially a wash,” he remarked.

The business cycle outlook, however, is a clear positive for equity markets, Robison stated. “Low inflation and heavy levels of stimulus should lead to a positive environment for stocks,” he noted. Valuation, on the other hand, is not as compelling as it was in late March and is a bit of a headwind to the outlook, Robison said.

“All in all, staying the course and sticking close to strategic positions may be the best route to navigating today’s uncertain environment,” he concluded.