Q3 2020 Insights

How did the markets do?

• Equity markets rallied as re-openings in many economies exceeded expectations and hopes grew for a Covid-19 vaccine.
• Volatility picked up in September and into October as Covid-19 infections rose sharply in parts of Europe and the United States.  Political risk also intensified as Brexit tensions rose, stimulus negotiations collapsed in Washington, and the U.S. presidential campaign entered its final weeks.
• Equity returns were bifurcated, with investors paying hefty premiums to purchase shares of seemingly “pandemic-resistant” companies, while shunning most other sectors.  For reference, the top five firms in the S&P 500, now known as the FAAAMs (which currently comprise 20% of the index) have risen 40% year-to-date, despite their forward earnings only increasing approximately 10%.^[1]  In contrast, returns of the Dow Jones Industrial Average were still negative 5.4% at the end of October.
• Equities also moved higher in Europe, Japan, and emerging markets in Asia.  Returns were also aided by a weakening U.S. dollar.
• Fixed income markets were stable, with lower quality indices outperforming.  Investors’ increasing appetite for risk helped the market absorb a wave of new issuance and the arrival of many “fallen angels.”^[2]

• Most major economies appear to have climbed out of recession, however an acceleration in new Covid-19 cases in several regions may hinder the economic recovery as isolated lockdowns come back into force.
• Consumer spending in the U.S. has remained resilient over the past several months, but is concentrated in durable goods purchases (e.g. automobiles, real estate, appliances), while spending on travel and leisure remains anemic.  The recovery in the number of small businesses reopening has lost momentum and remains 20% below January levels.
• China’s economic recovery is well ahead of the rest of the world, but third-quarter real GDP growth was softer than expected.
• The global economy has relied on an emergency lifeline of robust monetary stimulus.  However, further fiscal stimulus is needed to support the global economy through a second (or third wave) of the virus, as well as to enhance the recovery on the other side.

What are we doing?

• Amid the increasing concentration at the top of the U.S. equity market, we are witnessing the premium between growth and value stocks reach new extremes.  Given this extreme disparity in valuations and the broad market’s dependence on growth stocks’ continued outperformance, we seek to maintain a balanced exposure between the two styles.
• As we continuously emphasize, diversification and remaining fully invested are important strategies that allow investors to benefit from multiple sources of return over time.  Well-diversified portfolios should look different than widely referenced benchmarks (such as the S&P 500), especially as those benchmarks become increasingly concentrated in a few companies.
• We expect fixed income returns to be particularly muted in the near term; investors should look to the asset class for capital preservation, rather than income or capital appreciation.  Low interest rates and trillions of dollars of new debt suggest a steepening yield curve.  Investors must turn their attention to what will happen to their portfolios when interest rates rise.

What risks are out there?

• Any deterioration or delay in the effort to contain the virus, or any complications in the development of a vaccine could cause markets to react negatively (and quickly).  However, these acute reactions are typically overblown, as evidenced by how rapidly markets corrected and subsequently have rebounded since March.
• Equity investors must endure these reactions in the short term to achieve long-term growth.  The key question for investors to ask in moments like this is whether their targeted asset allocation reflects their investment goals, time horizon, and especially their expected liquidity needs.

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