Below is our 4th quarter update. Expect a lot of back and forth in the markets the next few weeks. The election, Covid resurgence and stimulus talks are all at play here. This is in addition to a large chunk of the S&P500 reporting earnings. Have a good week. This too shall pass.
FOURTH QUARTER UPDATE – 2020
“With malice toward none; with charity for all... let us strive to finish the work
we are in; to bind up the nation’s wounds…” – Abraham Lincoln
LOOKING BACK, LOOKING FORWARD
The summer brought an economic rebound and a continuation of the stock market rally that began in spring. In late September, the Federal Reserve Bank of Atlanta's GDPNow tracker estimated real Gross Domestic Product (GDP) growth of 32.0% for the third quarter. All three of the major Wall Street benchmarks advanced in Q3; the S&P 500 added nearly 8%, ending the quarter up about 4% for the year. Even so, U.S. equities slumped in September as traders worried that the stock market might be getting ahead of the economy.
Just as an FYI, there are 5 companies that make up 25% of the value of the entire S&P 500. Those happen to be technology companies that are quite familiar names: Microsoft, Apple, Facebook, Google and Amazon. If you only owned these 5 companies your portfolio would have returned almost 48% so far this year. However, if you only owned the other 495 companies that make up the other 75% of the S&P 500 index, you would have lost almost 7%. This shows how the tail is and has been wagging the dog the past few years in the market. It also shows how lopsided this recovery has been. This is not the technology sector of 1999 where the companies were all losing money yet having their stock price rise to the stratosphere. The tech companies of today permeate almost all business and industry and are literally printing money.
In Washington, the Federal Reserve altered its monetary policy stance and forecast low-interest rates for the near future. Hopes for another economic stimulus dimmed in Congress. On Main Street, the coronavirus pandemic remained top of mind, but improvements in hiring, consumer confidence, and retail sales were evident.
Entering the fourth quarter, analysts wondered how nimbly the financial markets might manage some unknowns: a potential uptick in COVID-19 cases in the fall, the pace of vaccine development, the outcome of the presidential election, and undetermined prospects for additional economic support of businesses and households.
Wall Street enters the fourth quarter with a bit of uncertainty. The November election results may produce any number of reactions. There are only educated guesses as to when coronavirus vaccines may appear, and how effective they may be. The first reading on 3rd-quarter Gross Domestic Product growth is on October 27, roughly one week before election day.
Federal Reserve officials expect low-interest rates and very little inflation through 2022. Sustained low-interest rates could drive more borrowing and business investment and improve the outlook for the housing market. For more than a century, the Federal Reserve has had two primary monetary policy objectives: to manage inflation and to guide the economy toward a state of maximum employment. Historically, managing inflation has come first. So, it made news on August 27 when Fed Chairman Jerome Powell announced that the central bank would "seek to achieve inflation that averages 2 percent over time," rather than proactively adjust short-term interest rates when inflation approaches that established target. In other words, it would tolerate a little more inflation than it had in the past as a trade-off for spurring the economy. The Fed kept the federal funds rate in the 0%-0.25% range in the quarter, and its September consensus interest rate forecast showed it expected no change for short-term interest rates through 2022.
THE QUESTION ON EVERYONE’S MIND
This question is, “How will the outcome of the election affect my investments?” The answer no one want to hear is “It depends.” There are really 4 basic outcomes to contend with. A “red wave” in which republicans control the White House and Congress. A “blue wave” in which the democrats control the White House and Congress. The “status quo,” in which Trump is re-elected and the House and Senate remain divided. Finally, a Biden presidency with the House and Senate divided. Thinking through these outcomes is exhausting, I know.
How will these scenarios affect the investing world? Well, as I see it, the current focus of the market is on stimulus and how much it will receive. After all, Fed Chair Jerome Powell has basically come out and said the economy needs more stimulus from Washington. The market loves liquidity and “free” (though not really free) money. In the near term, the market will perform based on how much stimulus it believes it is going to get. So, let’s play out the scenarios from above.
Red Wave – Highly unlikely, but anything is possible. Trump says he wants big, bold stimulus and I tend to believe him. Politics aside, he isn’t afraid of debt and most likely doesn’t have a problem throwing money out of a helicopter. He tends to rate his performance on how the stock market is doing and helicopter money will push it higher in the near term. The problem here is more fiscally conservative republicans aren’t for spending money we don't have and thus a more muted stimulus package would be likely. However, in this scenario there would also be a push for less government regulation and possible additional tax cuts, including making the individual tax cuts from 2018 permanent. The market would probably like that.
Blue Wave – Again, politics aside, this is looking more plausible. In this scenario, a very large stimulus package is probably likely. The timing would probably be put off until after inauguration, but knowing it is coming would likely lead to a Santa Claus rally in stocks. Longer term, this scenario would most likely lead to higher taxation, which has never stimulated any economy. Taxes are only good for the party collecting them. Uncle Sam has never had a revenue problem; he has a spending problem. America is in debt to the tune of $27 trillion and growing by the second. We should be ashamed of the debt we are saddling our children with. One can’t live on credit cards forever and the piper will have to be paid someday. I just hope I’m not around when he comes calling. However, I digress.
Status Quo – Gridlock. Something will eventually get done, but not until it is an emergency. Especially with the bad taste that will be in everyone’s mouth post-election. Longer term, I won’t even speculate. Pre- Covid, the markets and economy were pretty resilient with tariffs, impeachment and the like. If a muted stimulus can get the economy back on track and we get a handle on the fear surrounding Covid, then the “status quo” economy could prevail as well.
Biden Presidency – Gridlock. At least in the beginning. I could just copy and paste the paragraph from above, but I won’t. Biden will pursue his agenda and may be able to reach across the aisle to get a little done, but not much. I’m no political expert nor do I wish to be. There are likely a myriad of other plausible outcomes of which one cannot possibly know. We will only know for sure when we look back.
There is one more option I failed to mention. A highly contested election outcome which ends up in the courts. I suspect this would be unpleasant in the very near term until an outcome is achieved. The market probably wouldn’t collapse or anything like that. It could pull back a little on uncertainty as it always does. However, a contested election would be bad for this republic and bad for democracy in general to not honor the outcome of free elections.
In reality, the stock market and economy have a good chance of continuing their rally into year end. After all, who isn’t ready to put this circus in the rearview mirror and move on. The dialogue in this country over politics has become nauseating for most. What happened to being able to disagree yet still behave as gentlemen and women? I’m not advocating for one candidate or another here and there are numerous additional policies which must be weighed in addition to fiscal policy. This country needs a calm, strong leader. I’m not so sure we have these qualities in either mainstream candidate. I’ve often wondered why those most fit to attain power are least fit to wield it. My hope after this most polarizing election is as Lincoln said it best “that we may have malice towards none and charity for all as we continue to do the work required to move forward and bind up the nation’s wounds.”
GOVERNMENT CONTROL - THE ECONOMY & THE STOCK MARKET
Stepping back, progress is often slow and contested, especially without explicit Congressional control. Political parties and their agendas have come and gone without shifting America’s long-term economic trajectory by much.
Needless to say, it is difficult to rework a portfolio in anticipation of election outcomes, market volatility, sector rotations, or changes in other hard-to-forecast macro factors.
Instead, maintaining a well-diversified portfolio to provide insulation from industry-specific shocks. Also, owning “all-weather” companies which rely less on uncontrollable forces, reducing the chance that their financial health and long-term outlook for profitable growth will fade quickly.
I’m not a big believer in timing the stock market either. One may get lucky if they only have to do it once, but no one can predict with consistency how the market will respond to elections or other factors over the short to medium term. And it requires surprisingly little time to miss most of the upside if you’re caught holding cash for too long.
Economists give economic recoveries what might be called a letter grade when discussing possible paths. It’s not the traditional A through F scale. Instead, the letter intuitively describes the shape of the recovery.
A V-shaped recovery would be ideal, as it would represent a robust bounce. Might we get a V? Data in May was unexpectedly strong and cautiously encouraging. However, even during what we might consider more normal times, forecasting is difficult. Today, there’s no playbook and no framework to model outcomes.
I could give you several reasons to see a strong rebound unfolding. I could also give you several reasons why a sluggish recovery might take place. The most likely scenario unfolding is the K shaped recovery illustrated below. This is essentially where some industries recover quickly while others languish. Some think we’ll see a convergence of the winners and losers as the economy normalizes and reaches equilibrium once again. The big question is when that will happen, but the reality is no one really knows. So much depends upon a slowdown in Covid, potential vaccines and moving beyond the fear of coming together again.
The strong rebound in stocks since the late-March low is astounding, especially given the economic damage. It suggests the collective wisdom of investors is more optimistic. Fed support, rock bottom interest rates, the reopening trade, and stronger economic data have helped. I also believe investors are looking past this year’s hit to corporate profits and are expecting an upturn in 2021.
The jump in daily cases has created some renewed volatility, and it bears watching, but it has yet to knock the bulls off course. Ultimately, the path of the virus will play the biggest role in how the economic outlook unfolds.
Some folks are itching to get back to normal, while others remain on guard against the disease and are taking a more cautious approach. It may take time for some businesses to fully recover. Some never will.
The stock market’s 90 best trading days between 1969 and 1993 – or barely 1% of that period – accounted for 95% of the market’s gains. If you were out of the market just 7% of the 780 months from 1926 through 1990, you would’ve earned nothing. Those stats are from studies by the University of Michigan cited in Ralph Wanger’s book A Zebra in Lion Country.
A similar dynamic can be observed overseas. Terry Smith, portfolio manager of London-based Fundsmith, noted that an index fund tracking the U.K. market from 1980 through 2009 generated a 700% return. However, missing the best 20 trading days reduced the return to just 240%. For context, there were about 7,000 working days during this period.
I haven’t a clue when those good days will occur, but no change in political party or deterioration in the economy’s short-term outlook will sway my view that stocks remain arguably the best passive vehicle to grow and preserve one’s wealth in the long term.
As the fourth quarter kicks off, the coming months will provide more clarity on how Covid-19 can be handled during the winter months, and what that means for the broader economy.
Amid acrimony on both sides, let me first say that my role is to be a financial advisor. I have worked hard to earn your trust. I am not a political analyst. I am here to guide you as you journey toward your financial goals.
Therefore, I will carefully and cautiously review the current contest through a very narrow prism–through the eyes of a dispassionate investor focused on the economic fundamentals and how that might impact equities.
Let’s consider these facts.
- Stocks have performed well under both parties.
- The conventional wisdom isn’t always right. Recall that stocks weren’t supposed to do well with a Trump win, as investors wanted the continuity a Hillary Clinton presidency would offer.
- Compromise and gridlock may engulf a dominant party, as a one-sided win tends to expose party divisions. Remember how republicans would quickly repeal Obamacare?
Some investors fret that a Biden win would lead to higher corporate taxes and heap more regulations on businesses. But might we see more fiscal stimulus and an easing in trade tensions, which could support shares?
Longer term, stocks march to the beat of the economy, Fed policy and corporate profits. A growing economy fueled by innovation and entrepreneurship has been the biggest driver of stocks over the many decades. In my opinion, that’s not about to change.
Overall, the last month confirmed that America’s economy probably faces a slow, uneven recovery, with mini outbreaks of Covid-19 cases interfering in different places and at different times. Social distancing could be here to stay for a long time.
I’d like to reiterate that I continue to believe the stock market represents arguably the best path to preserving and passively growing wealth, especially in today’s low interest rate world. While the next year or so remains shrouded in uncertainty, the world will get through this crisis eventually, just as it has every other shock throughout history. Nothing lasts forever, and as a dear client of mine used to tell me, “this too shall pass.”
If you have any questions or would like to discuss anything in this update or any other matter, please feel free to give me a call. As always, I’m honored and humbled you have given me the opportunity to serve you.
Nick Toadvine, CFP®
Guardian Wealth Management | 5116 South Lakeland Drive, Lakeland, FL 33813 | www.guardwealth.net
Securities and Investment Advisory services offered through Calton & Associates, Inc., Member FINRA, SIPC. Guardian Wealth Management, LLC and Calton & Associates, Inc. are separate entities.