Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Central bank stimulus and optimism over the pace of an economic rebound have allowed US stocks to recover all their losses for the year.

Building on the momentum generated by last week’s better-than-expected May employment figures, the S&P 500 index rose by 1.2% on Monday, sending it above the level at which it started 2020.

The rise took the Dow Jones Industrial average (DJIA) back to Q4 2019 levels as it continues its recovery, with the tech-focused Nasdaq up over 1% to set a new closing record of 9,924.75.

US indices have been working their way back into the black as investors digest the breadth of stimulus measures introduced by the Federal Reserve. On the back of sharp falls in March, stocks began to reverse on news of the central bank cutting interest rates to zero, instigating a sizeable bond-buying programme and introducing a range of lending facilities.

The result is that all three major US indices are broadly back in line with pre-coronavirus performance despite the National Bureau of Economic Research officially declaring a recession in the country, putting an end to the longest economic expansion in American history.

Are valuations justified?

And it’s this disconnect between increasingly sanguine markets and an uphill struggle ahead for the economy that has some investors on the backfoot. While tentative moves to reopen customer-facing businesses are boosting investor optimism, the country‘s unemployment rate is still sitting above 13% - higher than the levels seen during the global financial crisis. Businesses may begin to operate again soon but most likely on a reduced schedule, smaller workforce and restricted customer base.

It’s true that good investors look beyond the here and now but there is a danger that the market is willing a V-shaped recovery into existence before it’s ready. Looking through the noise is one thing but ignoring the significant impact to corporate balance sheets in the short term could prove costly, and provoke another correction when investors eventually reconsider valuations in light of Q2/Q3 results.

Of course, this caution would not have been rewarded had we all sat on the side lines, and stimulus plans have been implemented quicker than in 2008. But despite US indices springing back, most investors will hope the recovery this time round does not become a bull run to be hated as much as the last.

Nor will we sit comfortably if renewed optimism is borne entirely of central bank intervention and just a few tech mega-caps attracting global capital.

While we all wrestle with one of the most popular online searches of the year; “Is the stock market going to crash again?” the truth is the only way to make sense of it all is bottom-up research.

Companies’ fortunes stand on a precipice in many cases now, with sectors ready to separate the well-capitalised and patient from those who have been hit directly by the lockdown and are bleeding cash.

We only get to know which is which by studying company fundamentals, not by creating recovery stories for ourselves or hoping for an immediate return to normal. Whether you do this yourself or outsource the job to a fund management team, there is no substitute.

The reality is that uncertainty makes us wildly uncomfortable but we might have to get used to it as we slowly return to business as usual. Kneejerk reactions risk extending the discomfort.

Five year performance

(%) As at 8 June 2015-2016 2016-2017 2017-2018 2018-2019 2019-2020
S&P 500 8.6 31.0 11.8 10.2 14.6
Dow Jones 83 34.6 17.3 9.6 8.4
Nasdaq 8.5 48.1 18.7 10.1 36.0

Past performance is not a reliable indicator of future returns

Source: FE, as at 8.6.20, total returns in GBP terms

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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