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Economic Forecast Update

May 13, 2020

In December 2018 the S&P 500 was at 2,500. I forecast that the markets would be up 20% by the end of 2019. Then I wrote in May that I thought my forecast was low. I pushed my forecast that stocks would be up between 25% and 30%. The S&P 500 was up 29% to 3,250 by the end of 2019.

It's hard to follow that kind of market upturn with another upturn, but at the time I felt that earnings were continuing to grow at historic levels and the market was still undervalued. I forecast that the markets would be up between 10% and 15% in 2020. But then the world took a detour into the Coronavirus Contraction. As a result, I am adjusting my year-end 2020 target down to 3,100, with the Dow Jones Industrial's average finishing at 25,750. That would be a moderate gain of 5.8% from the Friday close.

The range of plausible outcomes for the rest of 2020 is very wide right now. Key variables include factors that are normally irrelevant to forecasting markets such as the spread of the Coronavirus, how quickly the economy opens, the development of therapies or a vaccine to fight the disease, and how quickly people are willing to go back to normal.

With the economy getting crushed, some analysts are wondering how equities could have bounced so hard from the March lows. We understand their confusion. With unemployment likely above 15% and real GDP falling roughly 7% in Q2, how can equities be doing so well?

One key to understanding this is that investors don't buy shares of GDP, they buy ownership stakes in a distinct set of companies, many of which are doing quite well despite the general economic carnage.

Imagine a company that has a major competitor nearby. One day, completely out of the blue, the competitor's facilities are all destroyed by a meteor. Obviously, no one would celebrate this catastrophe. However, when competitors go away the enterprise value of the surviving company rises, and you don't have to be an astrophysicist to figure that out.

In many ways, the spread of the Coronavirus has given larger well-capitalized companies, particularly technology companies and big box stores that were allowed to stay open, an advantage over Main Street competitors. And unlike Main Street businesses, a larger share of these companies are publicly traded.

It is hard to get your arms around valuations and markets if you are not exposed to them daily. Forcasting is just that, a guess based on known facts what is to come. Brian Wesbury, chief economist for First Trust Bank, is forecasting profits to fall about 25% this year and the 10-year Treasury will rise from 0.6% to just 0.9% by year-end. In other words, even at 3,100 I believe the S&P 500 will still be undervalued. And with profits rising in 2021, we think the S&P 500 can then rise to 3,650, a year later than we originally forecast.

One reason to be bullish on equities is that these days Quantitative Easing by the Federal Reserve is going straight into the M2 money supply and not into excess reserves. In the past three months, M2 has climbed at a 66% annualized rate, the fastest rate we know of in history.

Meanwhile, the federal government has ramped up deficit spending (with unemployment insurance and loans/grants to small businesses) to try to offset private-sector losses in income. Regardless of what we think of these policies, the effect will be to support equity prices in the year ahead. I am not trying to get your spirits up with just positive thinking. I am here to give you the facts and to then predict where I think your investments will be. The picture is certainly bleak, but the future still looks rosy, even though it will take longer to get to our projections.

As so many of you know, I am bullish on stocks over any other type of investment because I can see the light at the end of the tunnel and know that with a little patience, stocks will reward. Get outside and enjoy the warmth of the sun and get in some exercise. You will feel better to get away from the news, the politics and the negativity. Celebrate family and friends, spring, and your faith. The worst is behind us and I, for one see our economy bouncing back in a little different direction with power and sustainability.

 "This material is provided for general information and is subject to change without notice.  Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. The information does not represent, warrant or imply that services, strategies or methods of analysis offered can or will predict future results, identify market tops or bottoms or insulate investors from losses. Past performance is not a guarantee of future results.  Investors should always consult their financial advisor before acting on any information contained in this newsletter.  The information provided is for illustrative purposes only.  The opinions expressed are those of the author(s) and not necessarily those of Geneos Wealth Management, Inc."