The Broad View
Stocks stage powerful recovery in the face of ongoing challenges

If truth really is stranger than fiction, today’s stock market could serve as Exhibit A. First, the coronavirus outbreak plunged share prices into a record-fast bear market. Equities then raced to their quickest-ever new high amid clearly improved but still brutish economic data. Through it all, a haze of medical and social uncertainty clouded the outlook for the post-virus world.

The swift recovery underscores not only the head-scratching unpredictability of modern-day market moves — but also the significant risks to investors who try to time the market. Share prices have often rallied in advance of visible economic recoveries. But the recent swings — up and down — have come at hyper speed.

At tumultuous moments, investors’ gut instinct can be to step back from equities or hold further investments in abeyance until the clouds pass. The impulse is understandable. But it can be enormously costly. Anyone who sat out the S&P 500 rebound from its late-March low to its early-September high missed a prodigious 61% gain.

The rally has been powered by unprecedented monetary and fiscal stimulus, optimism over vaccine development and better than expected economic data. Unemployment has receded as economic lockdowns have eased. Pent-up consumer demand has propelled retail sales higher for four straight months. And manufacturing activity has risen above 2019 levels.

The Federal Reserve, which served up a bouillabaisse of economy-sustaining measures when the virus struck, continues to provide crucial support. In a historic move, the central bank did away with its decadeslong policy of preemptively hiking interest rates to avert inflation. The Fed also signaled that it will keep rates near zero through at least 2023. If needed, the central bank has room for further action in its emergency programs, including its Main Street lending and corporate credit facilities.

Significant economic and medical questions remain.

Despite the V-shaped recovery to this point, uncertainty remains high. Momentum in both the job market and in consumer spending has slowed recently. Jobless claims are down significantly from their March peak, but the pace of improvement has decelerated. That suggests an early burst of rehiring may be giving way as many furloughs devolve into permanent job losses.

A return to widespread lockdowns seems unlikely at the moment. But consumer sentiment has barely ticked up from its post-virus low, and a return to pre-pandemic spending habits may not arrive until an effective vaccine is developed and made widely available. The economic fallout has disproportionately hurt some industries and their workforces, especially lower-wage employees. Employment among workers earning more than $60,000 a year is down less than 1% post-virus, but it has slumped 16% for people taking home less than $27,000.

The outlook is further complicated by the diminished odds of additional fiscal stimulus. Thus far, congressional negotiators have failed to agree on a major aid package to replace the now-expired $600 a week in added unemployment benefits that had been a linchpin of the consumer spending resurgence.

The election presents a wild card.

Election season has stirred concerns among investors, given the acrimonious tenor of the presidential campaign and the potential for noteworthy policy shifts depending on which party ends up controlling the White House and Senate.  

Over the long run, the power balance in Washington has made essentially no difference in long-term investment returns. Since 1933, one party has controlled the White House and both chambers of Congress for a combined 42 years. During such periods, the S&P 500 averaged a 10% annual return. That’s nearly identical to the 10.4% average gains in years when Congress was split between the two parties. Even when one party had the presidency and the other controlled Congress, the average return was a solid 7.4%.

Still, market volatility has been elevated in both election years and in the early stages of economic recoveries. Such vacillations could be pronounced in the near term, particularly if the results of the presidential election are delayed. The aftermath of President Trump’s disclosure that he tested positive for COVID-19 could heighten investor uncertainty.

Depending on the outcome of the vote, there could be significant wealth planning implications for individuals and families. One of our trust and estate specialists offers important year-end planning tips in the article here.

Despite the surge in share prices and the particular dominance of large technology stocks, our portfolio managers continue to find opportunities across industries. That includes areas where equity values took a beating in the early days of the virus, but long-term outlooks remain promising.

Beer companies, for example, were hit hard by pandemic-related closures of bars and restaurants. Historically, such away-from-home sales have produced half of the industry’s revenue. But direct sales to suddenly housebound consumers have picked up and overall revenue is expected to reach pre-virus forecasts by 2023.

Our managers have also been drawn to insurance brokers. Investors broadly retreated from the insurance industry when the pandemic surfaced. But several segments of the industry are compelling, especially brokers, which connect consumers and businesses to insurers and negotiate prices. The pandemic has accelerated a dynamic of recent years in which insurance companies have raised premiums in response to a string of natural disasters. That benefits brokers, which receive a portion of those premiums but don’t assume the risk of payouts.

Bonds posted strong returns.

In the fixed income market, solid returns in the third quarter added to gains earlier in the year. The high-yield sector notched the best results and turned positive for the year as the easing of economic lockdowns bolstered the outlook for companies with below-grade credit ratings.

Treasury securities made minimal gains as yields remained at extremely low levels. But tighter credit spreads boosted corporate bonds: Investors were drawn to corporates as the improved economic backdrop reduced the risk of company defaults.

Municipal bonds also showed positive total returns as concerns eased about budgetary constrictions hindering the ability of state and local governments to meet debt obligations. Municipalities have a number of ways to make good on their obligations, including cutting expenditures, raising additional tax revenue and tapping reserve accounts. High-grade issuers have access to a special program created by the Fed to backstop the municipal market.

Given the possibility of higher tax rates in the future, municipal securities remain an attractive source of tax-advantaged income.

As always, it’s important to keep the potential benefits of fixed income in mind. These include income generation and capital preservation in shaky equity environments such as we’ve experienced this year.

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Fall 2020 Quarterly Insights

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