September 30, 2020

SHARE

Market Commentary
Following up the remarkable rally in the 2^nd quarter was going to be difficult. But, to the surprise of many, the 3^rd quarter saw the S&P 500 index reach a new all-time high before a mild pullback in September.  Markets (and all of us) continue to “look ahead”, anticipating that as time progresses a vaccine will lead to a return to normalcy. The question for investors is whether this equity recovery is premature. After all, the Fed has announced an extended hold at 0% rates. The Presidential election is on the horizon. And a vaccine, which seems likely to be approved shortly, will take some time to effectively distribute.  While stock indexes remain elevated, these on-going issues leave many market observers uneasy.

After posting a 20% gain in the quarter ending in June, the S&P 500 gained as much as another 15% before settling to finish up 9% for the 3^rd quarter.  Once again, technology stocks played a dominant role in the market returns. Stocks such as Tesla and Apple rallied on news of a stock-split (which does not increase the value of the company!). Many market observers attributed this market behavior to an increase in day traders using free trading services such as Robinhood, and the speculative nature of these share moves seems to support that theory. A technology-led correction did ultimately end the multi-month rally, but markets recovered before quarter-end to still finish with notable gains.  The VIX volatility index remains relatively elevated with readings in the mid-20s- a far cry from March when the gauge reached the low 80s. 

A key reason for the broader stock rally is the extremely accommodative path laid out by the Fed.  Chairman Powell laid out expectations for the Fed funds rate to stay at or near 0% out as far as 2023, which of course means that high-quality bond rates should be quite low for at least that long.  The 10-year Treasury yield remains largely unchanged in a range from 0.65% to 0.70%.  This “holding pattern” type approach led to an almost flat quarter for both Treasuries and the broader investment-grade bond class.    High Yield bonds had a solid quarter, with the index up about 4% for the period, but they still lag well behind investment-grade bonds year-to-date after a weak first half of 2020. Extending bond duration today does not provide much income, so fixed income investors have been forced to reduce credit quality or accept lower yields.

Looking ahead, much attention will be placed on the election, coronavirus infection rates, the willingness for respective states to re-open, the open Supreme Court seat following the death of Justice Ginsburg, and on-going economic issues related to the lockdown. And while 2020 has been a year to forget, for most investors it has also been a year of resiliency. We continue to advocate market participation, and believe that investors can continue to find attractive values and portfolio income despite today’s challenges.

We have identified key data points in recent market commentaries. While these metrics can be difficult to rationalize in this unusual environment, here is where they stand:

• Valuations. Valuations dropped to about 15.5x existing earnings in late Q1.  Earnings have risen for many stocks since the Q2 “bottom”, but so have share prices- and that has led to stocks remaining valued at roughly 21.5x forward earnings projections (source: JPMorgan).  This continues to be high, so much attention will justifiably be placed on whether growth can bring that number down close to historical norms. 

 

• Economic growth. GDP change was revised to -31% for Q2. That quarter was as awful as most expected as we all lived through a complete freeze of business activity. Q3 estimates are for around a 35% gain (source: Atlanta Fed), as the economic ice begins to thaw.

 

• Interest rates. The Federal Open Markets Committee has projected short-end rates to remain at or near 0% out to 2023.  As mentioned above, 10-year Treasury rates have been range-bound between 0.6% to 0.7%. The yield curve has remained fairly upward sloping, after inverting earlier in the year.

 

• Currency. The USD has continued the recent trend of moderate weakness, and this has continued to help returns for non-U.S. based securities.  The trend of dollar softening has played out in recent quarters after a long period of relative strength.

Portfolio Positioning
There is nothing like a record-fast bear market, followed by a record-fast bull market to encourage investors to “stay the course.” The continued rally has left those with cash uneasy about investing, but also unhappy about the low returns of money market funds and CDs. We maintain cautious toward increasing equity allocations in client portfolios in this environment, but continue to believe clients are best served by maintaining their long-term allocation targets. A dollar-cost averaging approach could be prudent for investors looking to increase equity exposure.
For bond allocations, we are looking to take on modest levels of lower quality positions to augment yield. For stocks, our focus continues to bias Value positions such as dividend-stocks. Dividends can be a great income replacement in this zero-rate environment. We also continue to advocate an Alternatives exposure, which has the potential to generate less correlated portfolio returns.

Asset Class Review
The third quarter saw positive results from all major stock indexes. The S&P 500 TR returned 8.93%, while the Russell 2000 returned 4.93%. Every sector of the S&P 500 was positive except for Energy, which was sharply down even while oil price held mostly steady.  Gains were led by Discretionary, with Industrials, Materials and Tech close behind. 

Conventional bonds also provided modest positive results, with the Barclay’s Aggregate up 0.62%. High Yield was strong on the heels of the economic recovery trade, the Barclay’s US Corporate High Yield index was up 4.60%. Commodities were also collectively positive for the quarter, with big gains in gold for much of the quarter. GLD finished the quarter up 6.61%, while oil prices were roughly flat.

Foreign stocks performed closely in line with domestic stocks this quarter, with sizable gains for Emerging Markets (MSCI EM up 9.56%) along with solid returns in both Foreign Developed and Foreign Small Cap.  These classes continue to trade at broadly much lower valuations than domestic stocks, and provide higher average dividend yield. We continue to believe clients will benefit long-term from continued global exposure in their portfolios.

Past performance is not indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be profitable or suitable for a particular investor's financial situation or risk tolerance. You cannot invest directly in an index. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses. Source: Morningstar

All opinions and data included in this commentary are as of September 30, 2020 and are subject to change.  The opinions and views expressed herein are of Cutler Investment Counsel, LLC and are not intended to be a forecast of future events, a guarantee of future results or investment advice. This report is provided for informational purposes only and should not be considered a recommendation or solicitation to purchase securities. This information should not be used as the sole basis to make any investment decision.  The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed.  Neither Cutler Investment Counsel, LLC nor its information providers are responsible for any damages or losses arising from any use of this information.

 

Tags: