Investing in the “In-Between”

9 Minute Read

July 17, 2020

Quarterly Market Commentary

At the beginning of the third quarter, investors sit in the uncomfortable middle. While progress in managing the COVID-19 outbreak has been made, further economic progress will be largely reliant on the healthcare response, monetary policy support and aggressive fiscal policy. Given all of the uncertainties, the growth outlook remains murky.

While the forecasted path of economic recovery is gradual, both global Risk and Risk Control markets delivered a “V-shaped” recovery during the second quarter. This occurred despite stutter-step progress combatting COVID-19, particularly in the U.S. Swift equity market recovery was driven by the combined firepower of extraordinary fiscal and monetary measures around the world, intended to build a durable bridge to eventual economic recovery.

The most important question for investors today is how strong, and how long, these bridges will be. Our base case calls for the need to fortify bridges as the pandemic continues to spread across certain global hot spots, including some large U.S. states, making economic recovery more gradual, and more vulnerable.

Below is a summary of our expectations for the economy and markets during this “in- between” stage.

Macro Outlook

Stop Spilling the Ink: The Shape of the Recovery Remains Unknown

There has been a lot of ink spilled on the forecasted shape of global economic recovery: Will it be “V,” “U” or perhaps “W” shaped? For forecasters, the basic components of the analysis are held captive by the pandemic. As time passes, we learn more about the virus and how to both control and treat it. We also understand that controlling the spread of COVID-19 comes at a near-term economic cost and that ultimately, that tradeoff decision sits in the hands not only of government officials but also companies and consumers. For example, we have seen companies slow reopening or change requirements, regardless of government policies, as the virus continues to spread rapidly in some U.S. states.

However, while we don’t know the magnitude or speed of travel for the global economy, we can see that the direction is forward. And we do expect recovery to take hold in a more durable, predictable fashion toward the latter half of 2021, most likely coinciding with the successful development and distribution of a vaccine. Until then, data will be inconsistent and unreliable, and the fits and starts nature of the U.S. economy will have implications around the world. This means:

  • Growth will likely disappoint those looking for a “V” shaped recovery.
  • While Europe continues to heal economically and has managed to successfully flatten the COVID-19 curve, and data suggests a recovery has also taken hold in China, the U.S. remains a wildcard. The COVID-19 hotspots of California, Texas and Florida collectively represent 30% of U.S. GDP.
  • Given the extent of global demand destruction, inflation will likely continue to undershoot central bank objectives. While economies are recovering from the COVID-19 induced supply shock, the deep demand shock is still early in the healing process, and global businesses are operating well below capacity. That said, extreme monetary and fiscal responses do beg the question as to whether we will see inflation reemerge as a threat in a post COVID-19 world. Bouts of inflationary pressure as economies continue to recover would not surprise us; however, broad-based, durable inflation seems unlikely.


Economies remain at the mercy of the virus, and durable recovery relies on continued progress on the healthcare front: testing, tracing, containment, treatment and prevention. Until more significant progress is made, we believe that, while there may be a policy-driven tradeoff between the spread of COVID-19 and economic growth, ultimately consumers and businesses will make their own decisions and likely remain risk averse.

A Slow, Risk-Averse Recovery in the U.S.

Source: Northern Trust Asset Management, Bloomberg, Johnson Redbook same store sales, Open Table restaurant bookings, Moovit, and Transportation Security Administration. Weekly data for U.S. only through June 26, 2020.

Equity Market Outlook

A Bull Running in a Dark China Shop

After the fastest bear market in history during 1Q, investors experienced a rapid recovery in 2Q as the global equity market advanced 19.4%1, responding to the powerful combination of fiscal and monetary policy responses and progress on the treatment and prevention of COVID-19. Effectively, investors have looked past what will doubtlessly be a challenged 2020 earnings environment, pinning hopes on a 2021 recovery. Indeed, the range of potential earnings outcomes in 2020 is wide, as companies themselves remain unsure, with many not providing guidance to analysts. However, investors are willing to bid up equity prices, in some cases beyond what seems reasonable, as expectations for fundamental recovery next year meet extremely low interest rates. As a result, global markets appear to be selling at valuations above historical ranges. This is particularly acute in the U.S., where broad equity indices are well above 5-, 10- and 15-year levels, and a narrow market advance has left the top five S&P 500 stocks significantly overweight relative to their earnings contribution.

While valuations are a poor market-timing tool, there is some useful information embedded in today’s price-to-earnings ratio. For example, one important component to consider as we disentangle the various contributors to market valuation is the interest rate backdrop. On that front, we can be unequivocal: Rates will stay low for long, for even longer. We expect zero interest rate policy in the U.S. and negative policy rates in Europe and Japan to persist for the foreseeable future. As we know, the market is a discounting mechanism, and when the discount rate is extremely low – like today –investors are willing to pay more for each dollar of earnings.

That said, there is another important component to the valuation puzzle, as investor sentiment can play a pivotal role, and in some cases, overwhelm the low interest rate tailwind. Today, investors are expecting an earnings recovery, with particularly high confidence in certain stocks and sectors where valuations are particularly high – for example, in technology. High valuations buoyed by high confidence are vulnerable to bad news.

We remain “cautious not bullish,” believing that valuations may reflect unfound optimism on the earnings recovery front. The ultimate recovery may be more muted and take longer than investors want. Our near-term outlook is for low returns over the next 12 months, with valuations representing more of a headwind going forward. In this environment, it is important to note the following:

  • Earnings visibility is extremely low: 150 S&P 500 companies have withdrawn guidance, leaving analysts in the dark regarding forecasts.
  • The massive recovery is not the tide that has lifted all boats. Earlier, the U.S. market began to price in a more robust economic recovery, with a rotation into small-cap and value stocks reflecting increased optimism as states embarked on reopening. But as many of those plans began to change, investors rotated back into the large-cap U.S. tech names, which have continued to drive broad indices higher and now represent a significant weight across capitalization-weighted indices, like the S&P 500 and Nasdaq.
  • Emerging markets had a particularly good quarter, buoyed by recovery in China, which holds a heavy weight. Although there has been significant negative news related to COVID-19 in Brazil, emerging market indices are heavily weighted toward China and other Asian economies. In these regions, we have seen the virus well contained, a keen focus on keeping the curve flat and a renewed focus on government policies designed to support economic growth.


The natural question we receive when investors hear our forecast is, “Should I sell my stocks?” While the answer is certainly different for each investor – based on unique goals and risk preferences – we can offer some broad guidance: Given the magnitude of the recovery, now is the time to revisit your allocation and ensure that your risk tolerance is appropriately reflected in your cash/high quality Risk Control allocation. Amid uncertainty and volatility, investors are well served to have adequate liquidity reserves and bond portfolios to fund near-term goals.

Big Tech Reigns

Source: Bloomberg as of June 30, 2020. Past performance does not guarantee future results.

Fixed Income Market Outlook

Lower for Longer, for Even Longer

Global central banks continue to lean into “whatever it takes,” with aggressive action on both the rate and balance sheet fronts. We anticipate this will be the “new normal,” unless broad economic conditions change meaningfully. In some ways, this feels like déjà vu, as the post global financial crisis environment was characterized by extremely low rates and quantitative easing. This period, however, is all that and more: Central banks are coordinated with fiscal authorities to embark on a myriad of policies aimed squarely at stop-gapping the economy, and by extension, the credit markets. In the U.S., bond-buying is going beyond the traditional Treasury and mortgage-backed securities markets to corporate and even high yield credit, and central banks around the world have joined the chorus, vowing open-ended, aggressive stimulus.

At the depth of the market crisis in March, investors had begun to price in an extremely adverse economic outlook, anticipating massive credit distress and sending credit spreads to cycle highs. With the announcement of policy support came a global sigh of relief and a massive move lower in credit spreads across investment grade and high yield in the U.S. and sovereign bonds in Europe. The central bank “put” is certainly at play, and we believe it will continue to durably support credit markets during this in-between period.

With our expectation for credit spreads to remain well behaved and our forecast for global interest rates to remain low for an extended period, we continue to favor both investment grade (for its Risk Control qualities) and high yield as part of Risk Asset allocations, given our positive risk-adjusted return forecast. To summarize, the underpinnings of this outlook are as follows:

  • We are back to the future with a “low for long” rates forecast and do not anticipate the Fed raising rates over the next three-to-five years.
  • Other central banks have also affirmed their outlook for extremely accommodative policies, leaving rates anchored at very low levels.
  • After having healed, credit spreads in the investment grade and high yield sectors will likely remain well-anchored with central bank support.


With starting yields so low across investment grade bonds, including municipal bonds, many investors are tempted to reduce their exposure to fixed income. We recommend always – but particularly now – to resist that temptation. High-quality fixed income remains a reliable source of portfolio diversification, and it is important now to consider where we have the highest confidence: We are highly confident that the Fed will maintain incredibly aggressive monetary policy and lend support across the credit spectrum if needed.

Unwavering Support: Growth of the Fed’s Balance Sheet

Source: WM National Investment Practice, St. Louis Fed - FRED Economic Database. From January 1, 2018 to June 30, 2020.

Private Equity Outlook

We continue to receive many questions about private equity – both from interested investors looking for greater return potential and current investors concerned about meeting capital calls amid a highly uncertain business and economic climate. In summary, this is what we tell them:

  • For qualified investors, private equity may offer important potential benefits, including higher returns (than public equities), portfolio diversification, and perhaps less obviously, a natural defense against behavioral biases: Selling out of fear during market stress is simply not an option.
  • Private equity should be viewed as a strategic asset class. Qualified investors should maintain constant allocations as part of a diversified portfolio.
  • Allocations to the asset class require meaningful and ongoing commitment, given long investment periods and ongoing distributions from maturing funds.
  • Manager selection is critically important to deriving benefits from the asset class.
  • In terms of the current opportunity, many companies are struggling and increasingly turning to private capital to survive the crisis, creating opportunities for experienced private equity investors. Further, we do see some evidence that private equity returns have historically been above average coming out of recessions. However, it’s important to note that returns for public markets have also historically been above average during such periods.


Private equity may offer important potential benefits to qualified investors but is best viewed as a strategic, long-term investment requiring ongoing commitment throughout market cycles. If you haven’t already, talk to your advisors about whether adding exposure to your diversified portfolio would make sense for you – and your unique goals.

The Bottom Line

Markets are forward-looking mechanisms that discount forecasted cash flows using prevailing interest rates. High rates mean lower present values, and low rates mean higher present values. We are clearly in a low rate environment, so we anticipate that valuations will remain elevated relative to history.

That said, cash flow streams are less certain today, given not only COVID-19 interruptions to global economies, but also uncertainty related to the “new normal” post-COVID world. To the extent that social distancing and “work from home” are longer-lasting characteristics of the new normal, we would expect aggregate earnings growth to potentially slow and for economic pressures to mount, on small businesses in particular. While we also anticipate long-lasting monetary and fiscal support, there is a risk of policy fatigue, should the virus’s impact be felt for a longer period of time. Under that scenario, we would expect investors to become far less patient.

The bottom line? If you haven’t already, work with your advisors to revisit your allocation, ensure your risk tolerance is appropriately reflected and right-size your Risk Control portfolio. This process can provide confidence and peace of mind as we navigate the “in between” investment landscape.

  1. As measured by the MSCI ACWI Index.


This document is a general communication being provided for informational and educational purposes only and is not meant to be taken as investment advice or a recommendation for any specific investment product or strategy. The information contained herein does not take your financial situation, investment objective or risk tolerance into consideration. Readers, including professionals, should under no circumstances rely upon this information as a substitute for their own research or for obtaining specific legal, accounting or tax advice from their own counsel. Any examples are hypothetical and for illustration purposes only. All investments involve risk and can lose value, the market value and income from investments may fluctuate in amounts greater than the market.

All information discussed herein is current only as of the date of publication and is subject to change at any time without notice. Forecasts may not be realized due to a multitude of factors, including but not limited to, changes in economic conditions, corporate profitability, geopolitical conditions or inflation. This material has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Northern Trust and its affiliates may have positions in, and may effect transactions in, the markets, contracts and related investments described herein, which positions and transactions may be in addition to, or different from, those taken in connection with the investments described herein.

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