Great quarter for stocks - Now what?

If I told you that the equity benchmark was up over 20% for the quarter, and global stocks were up close to 17%, you would respond that economic fundamentals were through the roof. The pandemic and lockdown shock came in March and we are now reversing the market constraints, but it looks like we are facing a "square root" and not a V-shaped recovery. 

The second quarter was the market of disconnect. With massive liquidity injections and fiscal stimulus, a bounce should have been expected, yet a return to anything like normal seems a stretch. The third quarter see the market of economic reality. 

• The GDP nowcast for the second quarter from the Atlantic Fed has improved but there is no mistake that the economic shock was severe.
• The New York Fed nowcast shows a positive third quarter but nothing that will offset the second quarter shock.

   

Concern should still focus on the simple law of uncertainty. If there is more uncertainty, spending will slow, cash will be raised, and investment decisions will be delayed. Save cash, and delay decisions until tomorrow.

• The policy uncertainty index has reached all-time highs. 
• The business uncertainty index shows a small improvement for sales growth while the capital investment and employment growth indices are surprisingly stable.

Uncertainty causes decision delays. Sales will fall,  and capital goods will not be purchased. Investment plans will be scuttled. No amount of new money will change this reaction. There is no discount factor that will make uncertain cash magically more positive. The animal spirits of optimism will have spoken. Realize that if uncertainty is resolved and is more pessimistic, the impact will be worse.

Investors were given a gift from central banks, a chance to get their asset allocation houses in order. This gift should be effectively used to protect from downside risk. Of course, the cost of significant derisking is high, but switching to factors and styles that are more defensive is still the right choice in a more normalized world that is not further shocked by policy.