Just a few months ago we were experiencing a barrage of headlines, an economic shutdown, and an extreme market drawdown. We are now weeks away from an election, residential real estate is hot, and we may see a record number of IPOs by yearend. Uncertainty is the theme of 2020.
Here is a concise update of what our Investment Committee sees as we all attempt to understand current global markets and what may or may not come next:
Science will eventually win and create a path to a sustained, global economic recovery, but the timeline is still not clear. Going forward, employment data will be a key contributor to much needed economic stability. While no one has a crystal ball, it is reasonable to question if we have seen the full expression of financial stress that this pandemic has caused for families, small businesses, non-profits, and corporations.
Stock prices are at historical highs. Equity valuations as measured by the Price/Earnings (P/E) ratio are well above pre-COVID levels. While the market appears to be looking past the current economic downturn, it seems a bit too optimistic that corporate profits will be above pre-COVID levels in the next year or two.
Don’t forget about value stocks. Growth companies have outpaced the returns of Value companies for several years. So far this year, this disparity has been historic, with Large Growth companies outperforming Large Value by over 25%. Much of this is attributable to a small number of technology stocks (the “FAANG” stocks). Many of these have benefited by circumstances surrounding the COVID pandemic (just think of the number of Amazon boxes out on recycle day in your neighborhood). Nonetheless, it raises the question if this disparity is sustainable.
International stocks look attractive. Europe appears ahead of the United States in terms of its recovery from COVID. Continued low Treasury rates, a large rise in the budget deficit, along with the sharp increase in money supply, all support a weakening US dollar which tends to make Foreign investments more valuable.
Interest rates can impact the bond market. With yields on the 10-year treasury well below 1%, finding value in the fixed income market continues to be a challenge. One approach is to chase longer maturities in an effort to capture higher yields. This introduces duration risk, where bond values decline when rates increase, with the biggest impact at the longer maturities. With rates so low, the consensus is that rates can only increase, making this a risky strategy. The other option is to pursue lower credit quality, that provides higher yields than Treasuries at given maturities.
No surprise, we are rather leery of increasing allocations to risk assets in any substantial way, namely those asset classes that have come so far so quickly, year to date. Do not be surprised by yearend volatility, especially if the election spills over from the ballot box to the courts. As you have heard from us many times before, allow your financial plan to lead the way. It can provide the kind of peace of mind that short-term market conditions are less likely to give. If you have a friend or family member who would benefit from this sort of advice, we would be delighted to help.