Market Update: September 10, 2020
The market continues to break records, with the S&P 500 delivering its strongest August performance since 1984 (Figure 1) and pushing the index to all-time highs only 103 days after the trough. This rapid recovery makes it the fastest ever following a drawdown in excess of 20% (Figure 2).
Figure 1. Despite seasonal headwinds, August was the strongest month since April 2020 and the strongest August in 36 years.
Figure 2. The current market represents the third-fastest recovery to a new high since World War II.
Broad Growth Continues as Unemployment Concerns Ease
As in July, market strength was consistent and broad-based; in August, only two sectors posted negative returns (Figure 3).
Figure 3. August continued July’s pattern of broad market growth, with only two sectors posting negative returns.
The market at all-time highs appears oddly juxtaposed with an economy characterized by high unemployment and increasing default data, but there is historical precedent (Figure 4). And while such an extreme divergence seems bizarre, remember that the plight of the average American does not substantively impact the earnings of the big corporations which make up most of the equity markets. While we acknowledge that many Americans are currently experiencing a range of economic difficulties, unemployment statistics show the strain is somewhat easing. The reality is that the mathematical impact of unemployed workers’ lost income does not move the needle on sales for the larger companies in the index. This is also an excellent example of our long-held assertion that the market is not the economy.
Importantly, as shown in Figure 4, in previous instances the official end to the recession occurred during the same month the market reached an all-time high or in the subsequent month. The Federal Reserve’s recent decision to focus less on dampening inflation and more on letting the economy run hot to lessen unemployment should help nudge the overall economy in this direction.
Figure 4. This is not the first time the market has hit a new all-time high while the economy is in recession. In all prior cases, the recession ended concurrently with the new all-time high or quickly followed.
Sector-wise, energy continues to be the black sheep. It will likely remain so as long as oil prices remain relatively stagnant and corporate balance sheets in the sector remain laden with debt.
The usual suspects of technology and communication services picked up steam again after a July respite, but—significantly—we also saw positive follow-through in economically sensitive sectors such as consumer discretionary (even if we exclude Amazon), industrials, and materials. U.S. Large Cap equities, up 7.3%, posted their best month since April. That’s no shock, considering that in August both Growth (+10.3%) and Value (+4.1%) gave us their strongest performances since April.
Companies are feeling better, as the pace of dividend suspensions and cuts continues to abate.
Taking our gaze away from the markets for a moment and focusing instead on the economy, the August employment report continued to defy expectations. As reported by the Bureau of Labor Statistics (BLS), total non-farm payroll employment rose by 1.4 million and the unemployment rate fell to 8.4%, reflecting continued resumption of economic activity that had been curtailed due to efforts to contain the pandemic. Economists were not expecting the unemployment rate to drop below double digits until 2021. Importantly, leisure and hospitality, the most heavily impacted of all sectors, had a strong month; more than half the jobs lost in that sector have now been recovered. Perhaps most important, the unemployment numbers improved across all demographics, as detailed in the BLS release. With extra federal unemployment benefits gone, having expired at the end of July, more people are stepping back into the workforce.
The Dollar Slows its Slide While Gold and Silver Consolidate
July’s biggest story was the slide in the U.S. dollar, but the dollar stabilized in August, down only 1.3% versus the 4% decline in July. Not surprisingly, the recent strong performance in commodities and international equities took a bit of a breather relative to U.S. equities. Both commodities and international equities had good months, but their performance took a backseat to a far stronger month in domestic equities. Given their recent strength, we think both categories are just taking a pause as they consolidate and set up strong bases for another leg higher while global economies improve and the impact of the virus eases with each passing day. Besides the U.S., we see many global markets near or at multiyear highs, including Canada, China, Denmark, Finland, India, the Netherlands, New Zealand, and Taiwan. We continue to favor the U.S. over both International Developed and Emerging Markets. However, that should not be construed to mean those markets are not doing well when viewed independently rather than relative to the U.S.
Gold was relatively flat in August (Figure 5). This lackluster performance for the month may look weak in comparison to U.S. equities, but it is actually a sign of a very healthy consolidation after gold’s sharp rise of 26.8% over the prior five months. Both the fundamentals and the technicals for gold remain solid.
Figure 5. August was a period of consolidation for gold, after its strong breakout earlier in the summer. The consolidation could continue in the near term, but that does not mean weakness is looming longer term.
Growth Beats Value Once More
U.S. Large Cap Growth equities continue to outpace U.S. Large Cap Value equities. August was very much like June, in that Value started the month strong only for Lucy to pull the football away from Charlie Brown, as Growth dominated the back half of the month. September has started relatively strongly for Value; Growth stocks, however, appear to have gotten out in front of their skis, riding on further optimism about the opening economy leading to funds flowing into the financial and hospitality sectors. Whether this persists throughout the month or whether Lucy yanks the football yet again remains to be seen. Meanwhile, we believe the long-term trend remains sharply in favor of Growth equities. We continue to scan the horizon, alert for signs that this is beginning to change.
Fixed Income returns were down for the month, the first down month as yields rose across the board on stronger-than-expected economic numbers and greater optimism on vaccine hopes. While yields have come back down somewhat in early September, they remain above their recent lows.
Seasonal Volatility and Market-Based Election Indicators
The market remains strong, having broken out in August. A breather is in order, though, and we’ve seen just that in the early days of September. From a seasonality perspective, September has historically been the most volatile month, and we have seen some of this volatility in recent days. However, like early June and early August, this market behavior looks to us at this point to be a healthy pullback from a market that was grossly overbought as measured against its 200-day moving average. This was most applicable to technology and related stocks, where the rise over recent months has been extremely sharp; thus, those sectors are bearing the brunt of the pullback to date.
While markets tend to move two steps forward and one step back as they trudge higher, in some cases it can be four steps forward and three steps back (i.e., more volatile on both the upside and the downside) when markets get too far over their skis. To us, this is nothing more than a pointed reminder that there is a reason why investors get a risk premium to own stocks. Stocks are not a riskless proposition. They’re subject to dislocations at any moment. And at times, these dislocations seem to occur for no reason other than the fact that there are more people who desire to sell than to buy.
Stocks are not a riskless proposition. They’re subject to dislocations at any moment.
We find comfort in the fact that bonds were part of the early September selloff as well, while yields across the yield curve rose. While it may seem counterintuitive that this would give us comfort, the selling across asset classes tells us investors are not selling equities out of fear and moving into bonds. Rather, after both asset classes have had substantive gains over the last many months, investors are trimming portfolios and waiting to see what opportunities present themselves—a sign of a healthy market. Even gold continues to exhibit some selling pressure as it consolidates. And while there are speculative aspects of the market (as exemplified by the parabolic rise in Tesla stock), the reality is that such elements remain confined to a much smaller portion of the market than the financial press would have you think.
Look to the performance of the market directly prior to the presidential election for cues on whether the incumbent party is likely to win. In 20 out of 23 presidential elections since 1928, the market’s performance in the three months preceding the election was a harbinger of the election result: either 1) the market did well and the incumbent won, or 2) the market did poorly and the incumbent lost (Figure 6).
Figure 6. Markets are a good predictor of presidential elections regardless of the political party in power.
Market seasonality and election volatility are facts of life, but regardless of how September turns out this year, our discipline does not try to sidestep such volatility; as long as our analysts remain constructive on the markets, we will remain overweight Market Risk. Steep pullbacks like the one we have seen to begin September are intimidating in the moment, no doubt. Nonetheless, they really are healthy—even necessary—for a market to continue higher, and they are to be expected in the context of the trajectory of the increases that preceded them. That said, we continue to closely monitor bond yields and corporate credit spreads. Credit spreads continue to slowly improve and the bounce in bond yields gives us reason to be optimistic about yields. Yields do remain lower than we would like to see, but as they are moving in the right direction, we will continue to take our cues from there on the likely direction of the economy. Our primary method of managing volatility is making sure that all investors are in the right strategy based on level of risk aversion and spending constraints. And of course, we consistently maintain the appropriate cash balance to ensure capital is never impaired should individual spending needs coincide with a pullback in the markets.
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