2020 Q3 Commentary
Well, we’ve made it through another quarter of 2020. Only one month to go before we have one more month then it is just one month left until a month to follow. That pretty much sums up how I feel about 2020. I’m sure some of you feel the same, so I just want to take a second to acknowledge that this has been a hard year for everyone.
The markets aside, this year has been a year that has challenged us as individuals, as parents, as sons and daughters, as co-workers, as a community, as a nation. We have been challenged in ways we probably never thought we would be. My hope is that we will come through this as better for having had these experiences. Maybe not in all the ways we would like to be better, but if even in some small way, then we have spent our time and energy towards progress. With that said, lets get in to what happened in the 3rd quarter.
Starting off with the economy, as many predicted and even more hoped for, Q3 had a strong bounce back, better than most expected. It is widely forecasted that we will see a 19.1% gain in GDP. Some believe that this may even be conservative, with several predictions for GDP growth that are closer to 30%. This is nowhere near where we would need to be to fully recover from the -31.4% plunge we saw in Q2.
For that, we would need a 45.7% rebound to be back to where we were at the beginning of the year and a 53.3% rise in GDP to get back to there we were this time last year. While a 20-30% gain in GDP is great, most indications show that the easy part of this recovery is over. While the unemployment rate has come down, we have only recovered 52% of all the jobs lost, not including the 4.4 million people who have exited the work force entirely. Most of these lost jobs are concentrated in the service industries like leisure and hospitality (19%), transportation (9.8%), and other services (9.2%)1.
This is not surprising as air travel is still down by 70% and restaurant dining is down 43%. This is of considerable note as service industries made up almost 79% of all jobs in the US2 and services as a whole account for 42% of GDP3. Moreover, many economists believe that without dealing with the pandemic we won’t be able to fix the economy. As the health effects of the pandemic continue to be drawn out, the importance of Congress providing additional relief measures grow. To the point that even Fed Chairman Jay Powell stated, in an uncharacteristically blunt manner, that without support the economy could fall into a recessionary downward spiral4.
Moving on to equities, unlike the 2nd quarter of 2020, the 3rd quarter ended with investors feeling very mixed as to what might lie ahead and offered both bullish and bearish cases for the near term markets. Continuing the growth of the 2nd quarter, domestic equities had their best quarter since 1998. The 5 month rally resulted in many indices actually turning positive for the year.
The markets fed off an open tap of monetary and fiscal support from central banks, better than anticipated corporate earnings, improving unemployment numbers, big tech’s ability to thrive in a COVID economy, and further progress towards developing a vaccine. By late August, however, we could already foreshadow the deadlock that would subsist in Washington on another stimulus package, stock valuations had become over extended, unemployment numbers began to plateau and corporations were facing increasing earnings expectations.
Come September, the bears finally had enough and wrestled control away from the bulls. In any other year a 10% dip over a three week period would have dominated the evening news but the confluence of a global pandemic, continued racial protests, a Supreme Court vacancy, and presidential election season, seems to have all but drown out the decline, as this claw back barely registered for most Americans. Despite the volatility in the trailing weeks of the 3rd quarter, the patient investor would have been rewarded as the S&P 500, international stocks, U.S. bonds, and gold individually returned 8.9%, 4.8%, 0.6%, and 13.3%, respectively.
Most notably, from its bottom on March 23rd, the S&P has gained 38.1%, recouping all of the value lost and then some, from the pandemic triggered sell-off5. This brings me back to a point I mentioned earlier, stock valuations. While the valuations have reached fairly high levels in today’s markets, we do not see the concern being as widespread as it was during the .com boom. There is a rather large portion of the market that is reasonably valued, or even still, undervalued. We would expect to see improved fundamentals in those undervalued parts of the market, such as energy, financials, real estate, and utilities6.
If we step off the thrill ride that is the equity markets for the safe haven of the bond market, the 3rd quarter was what we would have expected. The US Treasury yield curve basically remained unchanged with the short end of the curve falling just 3 basis points to 0.13% on the 2 Year Treasury note and at the longer end of the curve rising just 3 basis points on the 10 year T-Note to 0.69% and rising 5 basis points on the 30 year T-Note to 1.46%.
As the Fed has announced its plans to keep rates low, this will undoubtedly continue to keep mortgage rates down and the housing market strong but the trade-off will be a sustained low interest rate environment for investors. Generating income from investments will continue to be the thorn in every investors side as bonds have all but exhausted a nearly 40 year bull run. With rates so low there are only two places to go for income. The first place to look would be further out on the yield curve, but as I just mentioned, the 10 and 30 Year Treasury notes are not paying much more than shorter term treasuries, especially when we compare these to 30 year Treasuries that were paying 15.21% at its peak back in 1981.
So the only other place to turn is to head down the credit ladder. Just like when a person’s credit score is lower they will pay a higher interest rate on money they borrow as they are deemed a higher risk, so to do borrowers in the bond market. Which means that in order to generate higher yields you need to take on more risk. Not exactly a great option for the conservative part of the portfolio.
Assuming you are comfortable accepting some additional risk knowing what you own, particularly in the bond market, is key. There are several positions out there that at first glance that would appear to be relatively risk adverse options with impressively high yields. Attractive at the onset, but if you peel back the layers as we do, you would find that some of these options, one broadly used fund in particular, has nearly 90% of its holdings in below investment grade bonds and only about 5% in high quality instruments.
If you had held this position earlier this year when the fund price went from a peak of just over $21 per share to a low of $10.49 per share, your performance would have been worse than many stock portfolios and considerably more volatile than you were probably expecting. Compounding the loss, is the fund’s inability to fully capture the upside of the rebound because of the types of positions held within the fund, as it remains down about 21%. This is a strong reminder of why its imperative to view your portfolio with a long-term lens and structured with an amount of risk that can comfortably tolerate future volatility.
Lastly, I would like to touch on the up coming election. This is no doubt a high stakes election for a lot of people for many reasons, but for investors they should consider this yet another Tuesday. A couple of helpful visuals that I wanted to share about the election. If we look back at the markets, post Great Depression, there have been seven Democratic presidents and seven Republican presidents. Over that 85 plus year period the general market direction has been positive7
If we broaden our analysis to include Executive and Legislative branches we can see how its not necessarily who is charge but that there is continuity across the branches that has the biggest impact on market returns. Looking at the rolling six-month return for the S&P 500 for each calendar year and how the government was made up at that time (undivided Republican, undivided Democrat or a divided government) what we see is that the market can perform regardless of the party in power but what it really dislikes is not having the predictability that comes with single party control.
In the case of the current election, many have thought that a change from Republican to Democrat would lead to a downturn in the markets. But, what we have seen is that as the odds of a Biden win have been increasing, the markets have actually experienced strong results, with last week being the strongest week since July even as the betting line for a Biden win reached a new peak. Leading us to presume that Wall Street is becoming increasingly comfortable with a Biden win in November.
Even if we look election years specifically, we see that the market has been positive 19 of the last 23 election years dating back to 192810. Furthermore, studies have shown that those who remain fully invested during a full election cycle outperform those that sat on the sidelines9. What should matter to investors is not who is President but rather where their money is. Despite this, the average flow of investments into safer money market funds dramatically increases in years of presidential elections8. A diversified portfolio doesn’t care much who sits in the oval office. Staying committed to your long-term objectives will have a far greater impact on your portfolio than whomever is elected President.
Let me close with a very brief comment on the Coronavirus. If you are interested in following the progress of the vaccines check out the New York Times Vaccine Tracker. As of October 7th, there are 44 different clinical trials, including 11 phase three trials and five approved for early or limited use. This is absolutely incredible news given the history of vaccine production.
Thank you for taking time out of your day to share with us and never hesitate to reach out if you have any questions. We at Custom Wealth Management would like to wish you and yours the very best for an enjoyable Holiday Season!
1 https://www.statista.com/statistics/217787/unemployment-rate-in-the-united-states-by-industry-and-class-of-worker/
2 https://www.statista.com/statistics/270072/distribution-of-the-workforce-across-economic-sectors-in-the-united-states/
3 FS Investments Q4 2020 Economic Outlook
4 https://www.cbsnews.com/news/jay-powell-stimulus-economy-downturn-federal-reserve/
5 https://www.johnsonfinancialgroup.com/siteassets/documents/wealth/q3-2020-quarterly-outlook-final.pdf
6 https://www.morningstar.com/articles/1003476/33-undervalued-stocks-for-the-fourth-quarter
7, 8, 9 https://www.capitalgroup.com/advisor/insights/articles/how-elections-move-markets-5-charts.html?sfid=751003995&cid=80178295&et_cid=80178295&
10 http://static.fmgsuite.com/media/documents/dfa8e2eb-70a8-4830-bbab-2e967cef3871.pdf
