Week in Review

Week in Review: October 30, 2020

The Home Stretch…Hopefully

The major U.S. equity indexes wrapped up the week lower, recording their weakest monthly performance since March. Volatility once again subjugated financial markets, as an outbreak of COVID-19 infections across the country reawakened economic slowdown fears, eroding investors’ risk appetite. Concerns about the resiliency of the economic recovery in the absence of a substantial fiscal stimulus deal intensified this week, as the tally of coronavirus cases continued to accelerate in several parts of the nation, dovetailed with a rise in hospitalizations in a majority of states. Meanwhile, Congress’ inability to pass another round of fiscal aid before Election Day further weighed on market sentiment, as the bipartisan stalemate over the size and allocation of the next round of stimulus added a layer of uncertainty to markets. As a result, U.S. Treasury yields fell as investors gravitated away from equities toward bonds and other safe-haven assets. With risk tolerance on the defensive, oil prices also traded lower amid worries about weaker demand if the global economic recovery lost momentum. 

On the eve of an historic election cycle in the U.S., several factors — U.S. election uncertainty, delayed fiscal stimulus and a global resurgence of COVID-19 infections — have come together to change the near-term expectations toward a more negative view and sparked this week’s equity sell-off. Amid the uncertain landscape, we believe the longer-term outlook for corporate earnings is likely to be positive and the large amount of fiscal and monetary stimulus is a constructive backdrop. Still, markets can only ignore the near-term effects of politics and the pandemic for so long. While the Commerce Department reported on Thursday that third-quarter numbers for gross domestic product growth — the broadest measure of economic activity — expanded at the fastest rate on record in the third quarter (see Figure 1), it is worth noting that the economic crisis that stemmed from the COVID-19 pandemic is far from over, as economists estimate that growth will be much more modest and choppy in the months to come. Despite virus fears dominating investor sentiment this week, the Q3 GDP report was also in line with generally solid corporate reports during the latest corporate earnings season. So far, more than 260 S&P 500 companies have reported earnings. Of those companies, 85% have reported better-than-expected earnings, according to Refinitiv.

Looking at this week’s activity, we believe that the equity market’s sell-off is also set against a highly uncertain political backdrop as a result of the rising probability of a contested election, recent indications by Congressional members that deficits matter and may now be too high (which could result in a smaller stimulus package), and a strong rise in COVID-19 infections. Nevertheless, there is also a possibility that market weakness may last only for the short term, given that a reversal could occur if strong fiscal and monetary stimulus efforts materialize to fight the crisis. Financial aid from the government is anticipated to help boost spending among U.S. consumers, which is the engine behind domestic economic growth. That aid seems especially important at the present time, as coronavirus cases continue to rise and labor market conditions remain fragile. With only a few days until Election Day, new unemployment claims last week dipped to a new low during the coronavirus pandemic. However, they remain far higher than any other period in more than half a century. With U.S. markets down about 8% since September 2, and most of the downturn occurring since October 12, it is natural for investors to raise concerns, reduce risk exposure and look to discern whether the beginnings of a stock market correction could turn into a more durable bear market.

Under these conditions, a historical perspective can help illuminate some noteworthy reference points: Over the last 90 years, according to Ned Davis Research, 5-10% market corrections occur an average of 3.4 times per year. While at times alarming, we see corrections as a normal process of healthy markets, even after the downdraft back in March as COVID-19 closedowns were enacted. Looking ahead, we expect markets to swing strongly in the coming weeks as the political, and more importantly, the policy (taxes, trade, regulatory, etc.) direction of the U.S. remain under question. Although markets could remain bumpy in the near term, especially if the election results are dragged out, economists agree that that the U.S. is currently in the early stage of a recovery, helped in part by unprecedented measures this year from the Federal Reserve and Congress. Therefore, we think a longer-term perspective on equities should be the biggest driver of changes to asset allocation. In that regard, corporate profit margins aided by rising technology deployment are likely to remain higher than long-term averages. This dynamic should fuel both dividend and earnings growth, albeit at lower growth levels than in recent years. With a constructive longer-term view, we believe a near-term strategy that takes advantage of the volatility consists of looking for entry points into equities during strong sell-offs, and rebalancing aggressively back to long-term equity allocation plans in the face of market rises.

When looking for new opportunities, we recommend that investors focus on quality companies that are positioned to endure short-term volatility and have upside potential over the long term. Stocks that fit the mold have robust balance sheets to weather challenging economic conditions and provide upside should the economy recover faster than expected. Additionally, the pandemic has also accelerated a number of cross-industry consumer trends, particularly in the technology and healthcare space, where we expect some companies to not just survive the ongoing economic downturn but also gain market share and dominance. As we have reiterated before, holding additional levels of cash can serve as a liquidity buffer against volatility, and as “dry powder” that can be swiftly deployed to take advantage of opportunities that may arise during periods of turbulence. Although it’s easier said than done, the best strategy is to ignore the day-to-day gyrations in the market and headlines, and focus instead on the investment fundamentals, as this helps avoid making long-term investment decisions based on impulse. Various studies show that acting out of fear can undermine a buy-and-hold approach that has historically rewarded investors, due to the difficulty of accurately timing not only when to get out of the market, but also when to get back in, raising the likelihood of missing subsequent rallies.

 

Figure 1: GDP, annualized quarterly change

GDP 

Source: Thomson Reuters (as of October 30, 2020)

 

Market Returns (USD) as of 10/29/2020

1-Week

Quarter-to-Date

Year-to-Date

1-Year

Global Equities

MSCI All Country World


-3.9% -1.3% 0.1% 6.1%

S&P 500


-4.1% -1.5% 4.0% 11.1%

Dow Jones Industrial Average


-6.0% -3.9% -4.8% 0.8%

NASDAQ


-2.8% 0.2% 25.6% 36.5%

Russell 2000


-4.2% 3.6% -5.4% 0.4%

First Republic Founders Index

 
-3.7% 2.5% 12.7% -

Russell 1000 Equal Weighted


-4.6% 0.9% -3.5% 2.5%

MSCI EAFE


-4.5% -3.5% -10.3% -6.2%

MSCI Emerging Markets


-1.4% 3.6% 2.4% 9.7%

Fixed Income

ICE BofAML Municipals 1-10 Year A-AAA 

0.0% -0.2% 2.8% 3.5%

Bloomberg Barclays Intermediate Government/Credit

0.0% -0.2% 5.7% 6.2%

Bloomberg Barclays High Yield Bond

-0.9% 0.6% 1.2% 3.3%

JPMorgan GBI Emerging Markets Global Diversified

-1.6% 0.4% -6.0% -4.2%

Market Levels

Thursday

Week Ago

Year End

Year Ago

S&P 500


3310.11 3453.49 3230.78 3046.77

Dow Jones Industrial Average

26659.11 28363.66 28538.44 27186.69

10-Year U.S. Treasury Yield (Constant Maturity)

0.85% 0.87% 1.92% 1.69%

Gold ($/oz)


$1,867.59 $1,904.11 $1,517.27 $1,495.66

Crude Oil ($/barrel)


$36.17 $40.64 $60.41 $55.06

U.S. Dollar / Euro ($/)


1.17 1.18 1.12 1.12

U.S Dollar / British Pound ($/£)


1.29 1.31 1.33 1.29

Japanese Yen / U.S. Dollar (¥/$)


104.55 104.92 108.61 108.02