2020 Vision - 3rd Quarter
The tide has receded, so to speak, and we can now see who has been swimming without a proper suit. In this new “pandemic economy” investors are confronted with a bifurcated market of haves and have-nots.
Asset owners have benefited from US market averages rising to near all-time highs, but unlike previous bull markets, where broad swaths of the economy advanced, we find only a select few market segments receiving positive attention. Eight of the eleven subsectors of the S&P 500 Index have lost ground, with Energy and Financials experiencing the largest declines.
Stocks within technology, healthcare, and consumer discretionary (Amazon is classified in the last category) sectors have disproportionately prospered. Logic might suggest that at some point market sectors should revert to the mean, with current laggards outperforming. This may occur when true economic growth gains traction. However, this is by no means an assured outcome.
The S&P 500 Index is market capitalization-weighted, which means that the most valuable companies have the largest impact on returns. The index rose 5.6% during the first nine months of 2020, yet a portfolio of these same equally weighted stocks declined 4.8%. In other words, large companies have outperformed smaller companies. Historically, any spread between the two returns has been relatively muted and in past recoveries, the trend is often reversed with small company stocks outperforming large company stocks. The division is even greater when comparing US and foreign markets (the US has significantly outperformed). The extraordinary economic restrictions caused by the pandemic and subsequent stimulus response has led to extraordinary results.
As focused as the media is on stock markets, the bond market is arguably more important because of its significantly larger size and direct impact on the former. These two asset classes have had a high correlation to one another over the last four decades. Both stocks and bonds over this period have experienced solid returns. Today, we have record low interest rates and we infer, from their absolute levels, that returns moving forward could be muted when compared to historical averages. From a fundamental perspective, if stocks appear expensive, then bonds look very expensive. When inflation is considered, US Treasuries do not maintain their purchasing power unless rates continue to decline, which exasperates the issue in the future. With the 10-Year Treasury yielding just 0.70% at quarter-end, there is not much room for growth unless the Fed puts interest rates into negative territory as its counterparts in Japan, Switzerland, and Germany have done. We do not believe negative rates are likely here, but we do expect short-term rates in the US to remain near zero for the foreseeable future.
Diversification is key to reducing risk and improving overall returns. Broad market exposure, generally and over time, should result in exposure to more leaders than laggards. Empirical data suggests this is one of the reasons index investing has become one of the fastest growing approaches to investing over the past three decades. However, the last decade has seen fewer and fewer companies, primarily large technology companies, taking the lion’s share of economic growth. Over 22% of the S&P 500 Index is now made up of just five companies.
Success and failure in capitalistic societies (creative destruction blog) are uncovered as part of the free and open market process. Failures today outnumber successes and those that do succeed are doing so disproportionately. For all its shortcomings, however, our open markets are the most efficient method we know of at allocating financial capital to the highest and best use. Who controls the White House next year may change, but this will not.
EPIQ Happenings
▪ We will continue to support organizations that are focused on the under-served in Minneapolis/St. Paul communities and have funds remaining in our matching pool. Please forward the contribution receipts supporting the organizations of your choosing and we will match that amount until our fund is exhausted.
▪ Mark your calendar for Thursday, November 12th as we plan to host a virtual Investor Day. We will digitally (Zoom) host presentations from current investment opportunities that we feel are worthy of consideration.
As always, thank you for your time, trust, and partnership. Please contact us to continue the conversation.
EPIQ Partners