Looking Back on Q3
Equity markets had a strong Q3 as returns were buoyed by generally positive news. Earnings announcements early in the quarter came in well ahead of expectations. The job market recovered rapidly, and market participants received encouraging signs of progress from stimulus negotiations. Consumer spending, which accounts for 70% of US GDP, continued to increase despite fears of a pullback following the end of the increased unemployment benefits from the CARES Act. In September, some doubts began to creep into markets but not enough to erode the gains made in July and August. Primary drivers of these doubts include concerns over additional lockdown measures in Europe as COVID-19 cases increased, the rapid job market recovery appearing to lose steam, and signs that stimulus negotiations might move slower than anticipated earlier in Q3.
The Road Ahead | Q4 Economic Risks to Recovery
Concerns that started to materialize in September trading continue into our Q4 economic outlook. At this stage of the recovery, and with states across the US lightening lockdown restrictions, most market participants were hoping to see job market growth accelerate. Instead, the deceleration in job growth paired with the unemployment rate (still well above pre-lockdown levels) creates concern that many of the job losses we hoped would be temporary will end up being more permanent. These concerns are fueled by the growing uncertainty around stimulus negotiations, without which many businesses may increasingly be forced to close. Additionally, multiple rounds of layoffs have already been announced by several large companies that have yet to be captured in the data. We are seeing the labor force participation rate drop as individuals give up on reentering the job market. Lastly, consumer spending increased after the additional unemployment benefits expired, despite decreases in income as the savings rate dropped sharply. This dynamic is unsustainable without additional stimulus or an improved job market recovery. For now, consumers appear to have built enough savings during the beginning of the lockdown (when the savings rate spiked to historic levels) to maintain spending increases. Clearly, this cannot last indefinitely.
All Eyes on the Election
Insurance protection against market downside around the election is trading at all-time highs for any event (as measured by CBOE through their VIX Futures Markets). This means many market participants are willing to pay historically large sums to protect against the various downside risks they see for this election, which includes everything from concerns about policy proposals to more abnormal concerns—like the potential for prolonged uncertainty around who won the election because of the historic numbers of mail-in balloting. Regardless of how the election cycle progresses from now until November, and regardless of its outcome, we expect increased volatility from now through the end of the year. Much of the market news over the next quarter, and likely much of Q1 in 2021, will be focused on interpreting the different policy proposals from the candidates, along with positive or negative signs from COVID case numbers, vaccine trials, and therapeutics. These factors will have an enormous impact on market performance in the near-term. Still there are more long-term and less clear factors at play: it is unclear what impact either presidential candidate’s platform will have; nor do we know whether a vaccine will be publicly available in Q2 of 2021, or Q4 of 2021. We face massive fiscal deficits starting this year, which are likely to continue into 2021, regardless of election outcomes. Markets continue to respond positively to new rounds of fiscal stimulus, so we think it is fair to assume they will continue to do so. Large portions of these fiscal deficits, as well as various monetary policy tools, have been directed to stabilizing markets and asset prices in 2020. It is likely this will also continue into 2021. When the smoke clears from this period, longer-term investors will be forced to grapple with a world that has added massive amounts of debt to their balance sheet in order to maintain (not grow) their current economies as we enter the first sustained period where rates to refinance that debt have nowhere to go but up.
During the previous quarter, we continued along a path of gradually re-risking portfolios. We have always been global investors, and this quarter we made several buys in developed international and emerging market strategies. We made buys with the following:
- Brown International Small Company typically holds 45+ small and mid-cap growth stocks. This active manager is a bottom-up stock picker focused on companies that, “save time, lives, money or headaches.” Brown Capital was one of the first minority-owned asset management firms in the US. This fund has a strong track record dating back to 2015.
- WisdomTree Emerging Markets ex-State-Owned Enterprise Fund focuses on free-market emerging economies, by eliminating companies that are more than 20% owned by governments. This strategy under-weights state-owned banks and energy companies, and over-weights tech and consumer companies. This manager has outperformed its benchmark over the last 1, 3, and 5 years.
- MFS Research International Fund is managed by Victoria Higley & Camille Humphries Lee with over 50 years of combines industry experience. This fund owns over 100 different stocks and has the flexibility to invest across regions, sectors, styles, and market capitalizations. This manager has compiled attractive risk adjusted returns in up and down markets with below-average portfolio turnover.
- Schroders International Stock Fund is our last, core international stock exposure. This manager runs a high conviction portfolio of 50+ large and mega-cap stocks. They are currently strategically underweight in the financial sector and overweight in the healthcare sector. This fund has a strong track record dating back to 1985.
As always, we are available to discuss your personal situation and questions or concerns you may have. Thank you for your continued trust.