On June 23rd I posted the commentary below, and since then in conjunction with sending our quarterly client reports, I wrote of many "Divergences" in both financial markets and in our lifestyles during these Covid-dominated times. Below (in italic) I will integrate some of those communications and update my thoughts about where we are in the Covid-19 recovery cycle. For clients, friends and associates, I hope this provides some insight to help you better understand some of the complex dynamics that are creating the angst that many of us are feeling these days. Through that unsettling feeling, one based in large part upon a lack of clarity and control, I continue to be confident that better days are ahead as we rapidly make gains in the development of an effective vaccine.
- A recovery is underway and I believe we have seen the cycle low for the economy and for the financial markets. We expect to see headline-driven short-term volatility continue in both the stock and bond markets, with those markets overall being relatively directionless from current levels until Covid and other uncertainties (see #8 below) find some clarity. With the Federal Reserve and Treasury Department flooding the economy with cheap money, while headline news is bad, the good news is that this cash must go somewhere and stocks and bonds therefore have some ballast. This all has proven to be accurate, but with "the market indices" more on the upside than I expected, which I will explain below.
- The ultimate recovery will be square root–shaped. The early phase, probably lasting through the summer, will be “V” shaped, followed by a more gradual rise in the fall and beyond. We believe that square-root economy will not reach the level of 2019 GDP until 2022. It usually takes several years for a post-recession recovery to get back to the pre-recession pace. We continue to feel this to be the case, but with recent policy decisions to not open schools and colleges giving us additional pause, we suspect a possible dip in the recovery line from this recession.
- We expect Covid-19 cases to increase during the recovery but not to the level that would be considered a "second wave," and not requiring another national lockdown. If squashing regional spikes are required, now having improved medical treatments, the measures will be less draconian than what we have just experienced. Seems to be what is happening.
- The unemployment rate will come down to 10%. It will remain that high because of the number of businesses that have permanently closed or gone bankrupt during the recession. More than thirty million were unemployed at the bottom and only twenty million will come back to work in the near term. Companies have also learned during the lockdown that they can operate effectively with fewer workers and less office space. It is possible that a bipartisan infrastructure spending program could improve this somber employment outlook. Recoveries in employment may be slower than originally projected due to an unintended consequence of subsidized Unemployment Benefits prompting some to choose to not return to work as quickly as they might otherwise have done. With all eyes now on the November election, any hopes for a major infrastructure program will be delayed until post-election.
- The lockdown has made consumers somewhat cautious, especially in the sports, dining, entertainment and travel industries. Until a cure or vaccine is available, these more hands-on businesses will continue to be restrained; older, vulnerable people will spend more time at home; and the savings rate will continue to be elevated. This will put pressure on interest rates to remain low. All true, with no end in clear sight.
- While remote working and remote learning proved somewhat effective, we believe people want to interact and cross-fertilize ideas with each other. As a result, we expect offices and schools will resume face-to-face exchanges this fall in some form or fashion. Working from home will have a long-lasting impact on both office space (negative) and residential real estate (positive). This seems a mixed bag, with reopenings of schools and businesses taking a more "hybrid" approach to online and in-person. And, as anticipated, data indicates softening office prices and increasing demand for residential real estate.
- We are making significant progress in managing the symptoms of the disease now, but a vaccine will take time before it is developed, tested, manufactured in large quantities and available widely. Signs are encouraging that significant progress will take place before the end of 2021. Recent results of Stage 2 testing have been encouraging, now having several companies in Stage 3 testing...very promising.
- Beyond the uncertainties created by Covid-19, in the coming months the financial markets will need to digest additional stressors including the current state of social unrest, a contentious governmental environment and a likely season of negative campaigning with unknown outcomes. While the street protests seem to have calmed down, polarizing political rhetoric is ever present and election-oriented mudslinging is just starting to come to the forefront. The next three months will not be pretty.
- As mentioned in my client quarterly commentary, the "Divergence" between technology stocks and the rest of the stocks of corporate America is extraordinary. The good news (at least for the past few months) is that most all investors own an allocation of "growth" oriented funds, indices or stocks, and have benefitted from this inclusion of tech stocks. That said, having experienced prior bubbles of "Nifty 50" in the 1970's and the "Dot Com Tech Wreck" of the early 2000's, we are cautious in trusting that this trend will continue without interruption, and remain committed to staying diversified. The chart and analysis below from Strategas paint the picture of this "Divergence" to which I refer.
"Returns This Year Are Top Heavy
The five largest stocks in the S&P 500 have, for the most part, driven returns this year. As the chart below indicates, they are up +35% while the remaining 495 companies are down -6%. The real question this raises is whether the outsized weights of the very largest stocks in the S&P renders the diversification argument that lies at the heart of the case for passive investments moot."
"Apple Alone Generates More Net Income Than The Russell 2000
Continuing its reputation as one of the supposed unflappable “Tech” bellwethers, Apple is now within striking distance of being larger than the entire Russell 2000 from a market capitalization standpoint. Remarkably, from a profit standpoint, Apple has already surpassed the Russell 2000, as the small-cap index’s net income plummeted from an impaired economy with over 40% of its constituents now unable to turn a profit."
Source - Strategas Securities, LLC 8/5/2020
Based upon all of this, we feel that a balanced portfolio, as we currently have for most clients, continues to make sense for now. Looking forward we are studying these changing behaviors and business trends and are evaluating their impacts on the workplace, on real estate and on overall financial dynamics. From those considerations, we anticipate making portfolio adjustments in the coming months and will be in contact with you when our strategies are fully developed and ready to be implemented. We continue to maintain this position of balance, however are becoming increasingly more aware that a pullback driven by profit-taking in the technology sector could generate setbacks in the broad indices. This downdraft, should and when it happens, may allow us an opportunity to reallocate and take advantage of identified future post-Covid trends.
As always, please do not in any way hesitate to contact James or me with any questions, thoughts or concerns. Be well. Bob Webster
The views stated in this letter are not necessarily the opinion of First Allied Securities Inc., and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with notice. Information is based on sources
believed to be reliable; however, their accuracy or completeness cannot be guaranteed.