The Long-Term Approach to Market Cycles
“The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
Global markets showed continued, albeit surprising strength during the third quarter of 2020. Typically a seasonally weaker period for markets, perhaps it is only fitting, as 2020 has been a rather atypical year.
The benchmark S&P 500 advanced 8.93% for the quarter, bringing the index to a return of 5.57% in the year-to-date period. As a comparison, the Barclays Aggregate Index has advanced 6.79% and the Bloomberg World Index is up 3.79% in the year-to-date period through 9/30/2020. Despite a swoon in early September, markets regained strength and closed the quarter on solid footing.
October has been known for surprises throughout market history and this year delivered a doozy in the form of President Trump contracting COVID-19. The first lady and several other Administration officials have also tested positive – seemingly from a Rose Garden event announcing Supreme Court Justice nominee Amy Coney Barrett. While as of this writing the news is still relatively new, markets have thus far taken it in stride, even as polls show lost confidence in the ability to contain this virus.
As we begin the fourth quarter, investors appear focused on three major issues: the economy, the virus and the election. While they are all largely intertwined, it is a herculean task to parse and tease these issues individually. At its recent meeting, the Federal Open Market Committee (FOMC) statement provided a big picture explanation: “The path of the economy will depend significantly on the course of the virus. The ongoing public health crisis will continue to weigh on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” Thus, both parties have made these issues the centerpiece of their respective campaigns.
Split government has typically made it difficult to pass new legislation or measures (which is why markets prefer this over time). Despite this, unprecedented stimulus was unleashed on our economy earlier this year and has largely been a great success. In a rare instance, we applaud politicians – both Democrats and Republicans – for coming together as Americans. Additional stimulus measures were expected early in the third quarter, after CARES Act provisions ran dry in July. However, better-than-expected economic data, a reluctance to increase the burgeoning budget deficit and the upcoming election made some in branches of government adopt a wait-and-see approach.
Throughout the third quarter, employment improved steadily. In July, the unemployment rate was 10.2%, and by September, it had fallen to 7.9%. While continued improvement is important, the pace of jobs creation slowed last month. Consensus estimates for September suggested the economy would produce 850,000 new jobs but came up short at 661,000. That could be a sign economic growth is slowing, dimming hopes for a continuation of the V-shaped recovery.
During the second quarter (April through June), the US economy shrank by about a third (-31.7%). Data for third quarter economic growth is not yet available, but it is expected to show a significant improvement. The Atlanta Federal Reserve’s GDPNow estimates third-quarter growth could be as high as 34.6%. While a double-digit rebound would be welcome news, Aaron Weitzman of The Bond Buyer pointed out, a 34.6% rebound would not offset the second quarter contraction – the economy would need to grow by 46% to get back to even.
As stated above, it is a widely held belief that the path of the virus will dictate the path of the economy. As of October 8th, there have been nearly 122 million tests performed, over 7.5 million total cases and over 210,000 deaths related to COVID-19 thus far in the pandemic, according to the CDC. While daily case levels remain elevated, severe cases requiring hospitalizations and deaths have steadily declined or remained stable. As temperatures cool, forcing more people indoors, schools reopen and people in general relax standards, fear of a second wave continues to garner attention. While as a nation, we have learned a great deal in a relatively short period of time in regards to diagnosing, treating and preventing COVID-19, longer-term effects of contracting the virus remain unknown. What happens over the next several months may ultimately depend on what each of us individually and collectively do to protect ourselves and others.
As of this writing, we are in the midst of the Presidential election cycle and there is no doubt that these showdowns raise uncertainty and perceived risk among investors. While we have seen many such dramas come and go in our years in business, none seem to compare quite like the current environment of political polarization. In recent months and weeks, we have fielded several questions from our clients regarding the impact of the election cycle and our outlook.
While this election is certainly interesting, our job is to position portfolios according to your long-term needs and parameters. Thus, we need to think about the impact of the potential outcomes – in the short and long term to make sure that we are meeting the objectives that you have set out. To that end, we must prepare for all possible outcomes in the shorter term and be prepared to make longer-term adjustments as they unfold. As we sit today, the three most probable outcomes are: Biden victory with Republicans holding the Senate, Trump victory with a Democrat controlled Senate and House, and “Blue Wave” – Biden victory with a Democrat majority in the Senate and House.
COVID-19 and an uncertain economy have added new dimensions to what may have already been a landmark US election cycle. The key takeaway for markets and investors, however, is largely straightforward: The overall government election outcome may matter more than any one candidate’s success, and the impact of divided vs. unified government likely is a better predictor of future policies than which party’s candidates come out on top. From a market perspective, historically divided government scenarios (split) provide a better environment for returns than unified (sweep) governments.
In addition to the usual uncertainty before an election, COVID-19 has forced voters and pundits to let go of “normal” regarding election night. “It could easily be ‘election week’ rather than election day,” said John Lapinski, director of elections at NBC News. Many states are urging residents to vote by mail and election officials are bracing for a more time-consuming ballot-counting process. Ballots cast by mail require extra steps and increased use makes the timing of results more challenging. Thus, election experts have prepared for the possibility of a longer, more drawn out process that harkens back to “hanging chads” in the 2000 election.
Given these potential outcomes, we have positioned our portfolios with more caution than is typical. As has been the case for most of the year, we have elevated cash levels in many of our strategies. Given our view on interest rates, we have kept fixed income investments short in duration and high in quality. We have attempted to keep our position sizes more moderated and have trimmed positions as market conditions have dictated. We take these measures in an attempt to minimize risk yet understand in a generally positive return environment, we run the risk of underperformance in the short run. Once past the election and the subsequent reactions, we look forward to returning our sights on the bigger picture in a more rational environment. In our experience, investors will move past these headlines and there will be different outcomes depending on which candidate wins this election. Our role is to adjust the portfolios accordingly.
There is no shortage of concerns on the minds of investors today. While it is human to seek some degree of certainty – even if illusion – it is important to remember that surprises and uncertainty are about the only certainty in the financial markets. Each piece of positive news thus far in this crisis, be it vaccine data, therapeutics or increased testing, have allowed markets to slowly “climb a wall of worry” as they are wont to do during prolonged periods of crisis. As we write, a third and presumably final round of major stimulus is in talks. Whether that happens before or after the election remains to be seen, but does give hope to continued resuscitation of the economy.
Eventually, the markets will return to a focus on the natural cycle of the economy, free of virus concerns and responses. As we all look for a return to “normal,” the markets are no different. Our job as money managers is to navigate this process and look for risks or opportunities as the market cycles to other sectors and capital finds a new home, perhaps for a lengthy period of time.
As a reminder, over the past several years, we have enhanced our capabilities in both financial and behavioral planning. WealthSense, our monthly educational publication, continues to be well received. WealthMap – our comprehensive planning platform – aims to crystalize and simplify the financial lives of clients who have taken advantage of this capability. Riskalyze has helped us build portfolios that mirror client behaviors and expectations. These tools, when combined with our long history of investment management process and discipline, have served to make the financial lives of our clients stronger. As a result, our business is more robust and well-rounded than at any point in our history, and I continue to be incredibly proud of our team amidst this incredibly challenging environment.
As always, we value the trust that you have placed in our firm and we look forward to continuing our hard work on your behalf.
Sources: Sources: Index returns – Gemini Fund Svcs, Bloomberg; Economy and Unemployment – Federal Reserve, FRED, CBS News, Bureau of Economic Analysis, Federal Reserve Bank of Atlanta, The Bond Buyer; COVID-19 data – CDC; Election and Stimulus – politifact.com, CNBC, Kiplinger, Marketwatch, Barron’s
The information set forth regarding investments was obtained from sources that we believe reliable but we do not guarantee its accuracy or completeness. Neither the information nor opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. Past performance does not guarantee future results.