This year has been epic in its trials and tribulations and we would all like for it to be over. We empathize with you, as the longer this continues the more frustrated we become. This too shall pass and hopefully we learn things about ourselves that improves our lives. In the meantime, we hope that you and your loved ones remain healthy, safe and sane.
Within just five months we witnessed the fastest market decline in history, prompting the quickest recession and followed by the fastest recovery. Yet while baffling many investors, the S&P 500 Index® finished the first half of 2020 only 3% below where it started. We acknowledge that stock markets are “forward-looking” but given the headlines it’s hard to imagine that we’re close to full economic recovery – though we have seen the low point. We are also somewhat surprised at the resilience of the major averages given that recovery is going to take far longer than we envisioned when this began.Investors are placing their faith in a vaccine becoming available sometime early next year and economic activity resuming its pre-pandemic pace in short order. While we hope to see a vaccine this winter, pricing in a near-complete recovery is aggressive. We believe economic growth will continue improving but a full recovery will prove choppy, slow and extended.
With markets back to pre-crisis levels, there are concerning circumstances and trends emerging or becoming exacerbated.
We have written how growth stocks (technology, telecom, pharma) are outperforming value stocks (financials, energy, materials). The differential over the last decade was already wide and over the first half of 2020 it added another 24% – growth is up 12%; value is down 12%. If we look at technology vs. everything else, tech stocks are up 18% for the year; everything else is down 9%. We know that at some point this will correct and no one knows when. But we’ve all seen this movie before. It debuted in March of 2000 and robbed years of retirement from those who abandoned value to chase growth.
The market has become highly concentrated in just a few big names – Amazon, Microsoft, Facebook, Apple and Netflix primarily. There are sound reasons why these companies are attractive, yet at some point valuations will matter. The forward Price-to-Earnings ratio of the S&P 500 is now at 25x; the highest since 1998. While valuation is not a timing mechanism, we must remember that trees do not grow to the sky. These excesses are typically cured by the top coming down and not the bottom coming up, so while we continue to overweight the leaders, we are keeping our eyes wide open.
Only the technology, communications and consumer discretionary sectors have posted positive returns for the year. If the April/May period is repeated, we will see the value spectrum come back to life. This will only occur when new COVID cases are in retreat – which the S&P 500 has been foreshadowing lately. It has remarkably led new case counts by about three weeks and is forecasting now that case counts should begin retreating again. Only a vaccine will enable a full economic recovery, but the market has faith that one is near.The Treasury and Federal Reserve heaping stimulus packages upon the economy are the primary reason that markets continue to perform well. As we outlined in our Q1 commentary , the Fed has successfully so far levitated the economy while the pandemic plays out. That lifecycle is proving longer than anticipated and with enhanced unemployment benefits expiring next week, there is growing concern that consumer spending may retreat, rents and mortgages may not all get paid and the market will have overplayed its hand. Therefore, all eyes are on the continued supply of cash via further stimulus plans until an actual economic recovery can occur. This being an election year, expect further stimulus to sustain this rally.
We have longer-term concerns about all this new money entering the financial system. M2 money supply is 21% higher for the year – an increase of $4 trillion just in the US. Normally so much cash in the system would be quite inflationary. This time, because of slower spending, it’s the dollar retreating relative to foreign currencies. We anticipated this and used profits harvested during June to establish a position in gold. So far, this tactical move is paying off quite well and when a vaccine becomes available and economic growth accelerates, expect inflation and gold to accelerate, too. Another beneficiary is our foreign equity exposure which we expect to outperform the US markets over the coming decade.While this is a confusing time, one thing has been proven during the pandemic. Our paradigm of Goal Horizon Investing has allowed our clients to remain focused on living life (such as it is these days), as short-term income is insulated from market gyrations. We have also capitalized on opportunities presented by fear just a few short months ago.
We cannot be perfect with timing, with our investment choices or in our vision of how things will unfold. But we don’t have to be perfect when clients’ investment allocations to risk are dictated by their future withdrawal needs. It is a safety mechanism we purposefully engineered years ago and continues to prove its value.
We have a difficult task making long-term investment decisions with so many unknowns about the pandemic’s resolutionbut our paradigm ensures the longer timeframes needed for growth investments to succeed.
We are also faced with generating relatively safe income when interest rates are at yet another all-time low. While Treasury securities yield less than 1% the only way to produce a livable income is to take additional risk. This means accepting price volatility to obtain desired incomes. Our Income Strategy is our current laggard, as two debt positions experienced just such price volatility while continuing to produce attractive income. Prices will recover in a more durable economy, but it’s a prime example of how difficult it is to generate a comfortable income these days. We did use the dislocated pricing during March and April to build customized Structured Notes producing very significant income. Be sure to read about our Structured Note holdings, generating outsized income while interest rates remain near zero. Please stay safe and follow medical guidelines. We will come out the other side of this in better shape than we all thought possible in March.
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