July 31, 2020 Comments (0) Views: 629 National News

Why a V-Shaped Recovery Looks Unlikely Now

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Michael Wilson, chief U.S. equity strategist at Morgan Stanley, wrote recently, “We will see a V-shaped recovery for two reasons – the historic steepness of the decline in activity, and the unprecedented policy response.” The team at Hercules Investments LLC, a Los Angeles-based RIA/hedge fund and wealth management shop, doesn’t share that optimism and in fact projects a bumpy ride for the balance of this year.

In a research note, Hercules cites the following risks:

Equity market technicals suggesting that high return levels aren’t sustainable. “The five largest stocks in the S&P 500 now account for 20% of its market capitalization, exceeding the 18% concentration level reached during the dot-com bubble. The dispersion in returns and the consequent rapid decline in market breadth is clear.”

Deep cuts to capital expenditures. “Recently, the COVID-19 induced recession has forced companies to limit capital spending. Refinitiv data (of nearly 4,000 firms) estimates 2020’s cut in spending will be on average 12%, higher than the 11.3% decline during the global financial crisis in 2008-09, or the largest in over a decade.” Such reductions are typically associated with slower recoveries and underwhelming revenue projections, says Hercules.

Cautious rehiring. “Companies may rehire fewer employees or at a slower pace than investors currently expect.” Potentially exacerbating this effect are the accelerating trends toward digitization, automation and direct-to-consumer business moves.

Medical developments, which could skew either way. “While a successful antiviral therapeutic or a vaccine could save the day, a second wave of COVID-19 is currently sweeping the nation setting record highs. As with any vaccine, once proven successful it will take time to scale up production to necessary levels.”

•  Ongoing trade tension between the U.S. and China. “Based on exchanges between politicians on both sides, the situation seems likely to get worse on the margin. Greater geopolitical instability is typically associated with lower valuations.”

The upcoming elections. With prediction markets currently assigning probabilities of 78% for the Democrats to retain control of the House, 61% to occupy the White House and 63% to control the Senate, the 2017 Tax Cut and Jobs Act is in jeopardy, the Hercules team says. “If the tax law is reversed, it would translate into meaningful reduction to any forward EPS forecast.”

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