Market Update October 21st, 2020
It has been a memorable year for sure. The Corona Virus is getting better understood which is allowing the world economies to reopen on a country by country and state by state basis which we are seeing to be vastly different depending on where you live. This, on top of the elections being less than 2 weeks away, continues to hold a lot of uncertainty for investors.
As mentioned before, uncertainty can be an investor's friend. Human behavior is such that most people tend to prepare for the worst with uncertainty and this worst-case scenario tends to be priced into the market. It has been shown more times than not, the worst rarely comes to play. Stocks tend to move on better or worse news, not good or bad news. If there is better news than what is expected, those investments tend to move up.
The third quarter GDP numbers will be coming out soon. The Federal Reserve Bank of Atlanta is posting its estimates for annualized GDP to be 35.3% for the 3rd quarter. This would be the biggest jump we have seen on record. Of course, this comes off the very worst quarter ever posted. Corporate earnings tend to rise faster than GDP. If this is the case, expect a big jump in reported corporate earnings. Hopefully, these will show to be better than expected.
The pandemic has crippled a world that was full of debt to begin with. It is my experience that debt can be a very fast catalyst for change especially in those areas that are used to the status quo. In the U.S., Congress is spending money to keep industries afloat until the economy fully opens which is creating more debt to service while the Federal Reserve is answering this by using monetary policy to keep interest rates down and devalue the currency the likes we haven't seen since the end of WWII. What we saw after WWII was monetary policy that kept interest rates lower than inflation for close to 20 years. Monetary policy was able to essentially deflate the cost of debt over the period which showed up in the cost of living thus providing negative after inflation returns for treasury bonds and savings accounts. It was not a good time to have an income stream that was not growing with inflation.
Given the current state of the world, the question is how do we: 1) protect our portfolios from this risk; and 2) position portfolios to take advantage of it? I will attempt to tackle each.
1. Investing in assets that will not be affected by a devaluation of currency is important for long term investors. Corporate ownership, selected real estate, precious metals and commodities are examples of these. Corporations need to adjust their pricing of goods and services to stay above their cost, otherwise they will fail. They will naturally raise prices to reflect inflation over time. Precious metals, real estate and commodities tend to retain their real value during bouts of inflation. Stocks have an added benefit for an investor in that they are liquid which is important if you need to live on your assets.
2. If bonds gave negative returns after inflation during the 20 years after WWII, think of those who were able to borrow during that time and invest in an asset that goes up faster than inflation. As simple as that sounds, it is a tough strategy to follow. However, investing in stocks that have the ability and expertise to access the debt markets and use those borrowed dollars to grow faster than inflation can allow an investor to participate in strategic decisions made by a corporation that in a-round-about way will allow the investor to smartly participate in the use of leverage for extra growth.
As a current example, the current dividend yield of the S&P 500 Index stands around 1.75%. This compares to the 30-year treasury yield of 1.6%. This is such a rare event that you would have to go back to the late 1940s and early 1950s to see another time like this. The companies representing the S&P 500 Index have lien-able assets that make many of them able to take advantage of these historically low rates by borrowing with good terms to expand, buy their competitors at strategically favorable prices and/or simply buy back their own stock if the math works. I looked at the performance of stocks over the 20 years following WWII and find that reported inflation adjusted returns were considerably higher than all other 20-year periods of time. I think this type of leverage was a contributing factor to the outperformance of stocks during this long period of time. Cash is king and low interest rates allowed many of the largest corporations to access debt market almost as cash when opportunities presented themselves.
Given this, we believe stocks are still early in a secular bull market. Secular bull markets tend to last 20 years on average. We believe this bull market started in mid-2013 when the index reached its previous high (2000.) The secular bull market that preceded the Great Depression lasted from 1942 to 1969 (27 years.)
As for the elections, we likely will see volatility depending on who wins and the events that might lead up to and follow it. All those candidates that get elected will need to lead the country in a manner that helps create revenue to service debt while continue to run the economy in a manner that the electorate expects. I believe this will be done regardless of the election outcome and the economies of the world are likely to follow the same path this country and the world did after WWII. World privatization grew during that period in a manner that had not been seen before. I believe it is likely the world will see something similar as the world's debt slowly unwinds.
As events upfold, we will need to be intentional with your portfolio and move to where the opportunities present themselves while matching the goals you strive to achieve. The temporary stoppage of the economy due to the pandemic has forced change to occur in months what typically would take years. As therapies, treatments and vaccines become more available and make people feel safe again, we believe this will open the door to even more innovation, growth and wealth creation the likes we have not seen in a long time.
The elections will allow the people's voice front and center. The important thing is to get out and vote.
Please call or email me with any questions, concerns or updates on your personal situation and we can go over this in greater detail.
Continue to stay safe,
Rich
Information obtained from sources believed to be reliable. The comments in this update are my own, and reflect my personal opinions. This is not a blanket recommendation or solicitation to buy or sell any securities. Each investor must consider their own personal situation, objectives, time parameters, risk tolerance and overall allocation, and should consult with a financial advisor and do their own due diligence.