“Life and investing are long ball games.” – Sir John Templeton
“The world has a funny way of not coming to an end.” – James Grant
Every year we get to October and we are never really sure what’s going to happen with the stock market. See, this is the one month that historically has shown it can be really good. BUT … really tragic market events have occurred in past Octobers. Makes for an interesting ride. October 2020, while not containing any big, ugly market moves like Black Monday 1987, did prove to be interesting for investors. US large cap stocks were down, but the small and mid-cap indexes were both positive. Overseas equities were also negative. The Aggregate Bond Index was down on higher interest rates, but the dollar index gained strength vs. a basket of currencies. Commodities were off more than 2%.
U.S. & International Stock Index Returns
|Index October 2020 Year-to-Date|
|Dow Industrials (4.49%) (7.14%)|
|S&P 500 (2.88%) 1.21%|
|S&P 400 (Midcap) 1.91% (7.89%)|
|S&P 600 (Small Cap) 2.09% (14.16%)|
|MSCI World (3.15%) (2.78%)|
|MSCI EAFE (3.69%) (12.61%)|
|Bloomberg Agg. Bond 6.32%|
|CRB Commodity Index (22.10%)|
|US Dollar Index (2.47%)|
All data as of 11/01/2020, Source: Wells Fargo Investment Institute. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
As we stated at the top, you never know what October will give us as far as the stock market. With a highly contentious Presidential election in early November, the market became volatile in the final week of the month. This volatility led to losses for the S&P 500, but not as bad as it could have been. Keeping the analysis very simple, Chart #1 shows the selloff ending at an area of technical support. This is positive. Just as helpful, from our perspective, is that the volatility index ($VIX) was peaking around 40 at the same time. This is important as a reading in this range is more suggestive of a market getting ready to reverse higher than a market top.
Beyond the S&P 500, we found it particularly interesting that small and mid-cap stocks outperformed the large company indexes we follow on both a real and relative basis. Over the past few years, the large cap indexes have dominated due to the massive outperformance of a handful of stocks and the technology sector. We enter November contemplating the idea that change in leadership MIGHT be upon us. If there is a change in leadership occurring the implication for investors could be important.
Chart #2 is a ratio chart showing the relative performance of the NASDAQ 100 (which represents large company technology) vs. the S&P600 small cap index. For those not familiar with a ratio chart, when the line is moving higher the NASDAQ 100 index is outperforming and when the line is moving lower the small cap S&P600 index is outperforming. This is all on a relative basis.
As the chart plainly shows, large technology has been massively outperforming small company stocks for more than a decade. On a relative basis small caps are priced vs. large technology about where they were at the end of the 1990s technology boom. This is not a “normal” situation, but what we would consider a market extreme. In the aftermath of the tech boom small caps were the leader for more than 6 years.
Could we be set up for a similar secular change in the markets? Only time will tell.
Economics and Economic Realities
We are writing this a little later than normal as we wanted to have some clarity on how the elections turned out. As of today (November 5, 2020) it appears that former VP Joseph Biden will be elected President of the United States, the House of Representatives will remain controlled by the Democrats, and the Republicans will maintain a small majority in the Senate. This could change in the coming days/weeks as the vote counting isn’t completed in some states, but that is where we stand as of this writing.
For the stock market, this is a favorable situation for a number of sectors. Healthcare, for example, we believe will continue to be an attractive area as split government does not lead itself to either the government plan option for the ACA proposed by Mr. Biden, or price controls on pharmaceutical companies. We do, however, see a path that can lead to an infrastructure bill, which would be favorable for the industrial sector.
We also see two other factors that are important for investors: future higher taxes and a weaker dollar. For the record, we believe this is not a result of the election, but a result of the structural issues we face as a country at this point in time. To put it bluntly, as a country we are at the point where our “rich uncle” (read: foreign buyers of US Treasury Bonds) won’t pick up the tab for our reckless spending anymore by purchasing our debt. The future is about fiscal responsibility.
Energy & Renewables
One of the topics discussed in the news lately has been the idea that fracking could be going away. The implication has been that a push toward renewable sources of energy would wipe out the US energy producing sector. While we are a proponent of renewable energy and believe that it has a bright future, the blunt reality is that it will not destroy the oil and natural gas business.
Why you may ask?
Simply put, both US and global demand for energy grows over time. Consumption growth has slowed as we have become more efficient in how we use it, not because we are rationing it. Part of the journey of becoming more efficient energy users is the move to renewables. According to the US Energy Information Administration (EIA), Petroleum and Natural Gas are 69% of energy consumption while renewables are up to 11%. That number will increase over time, but the amount of energy coming from carbon-based sources will continue to be substantial, and certainly isn’t going away any time soon.
Regarding oil usage specifically, electric vehicles will have an affect on usage over time. With battery technology getting better, policymakers pushing for lower emission standards across the global, and the automakers get on board with EVs, there will certainly be a ramp up in the number of EVs on the road. But according to the BNEF 2020 Electric Vehicle Outlook , the global vehicle fleet will be 1.4 billion passenger vehicles in 2030 with EVs accounting for just 8%. By 2040 this rises to 31% as the fleet slowly changes over. And that’s the key – the turnover to just a majority of EVs will take decades to happen.
Our Takeaway: Renewable energy will be a big factor going forward but oil and natural gas will still remain a big part of our overall energy mix.
Asset Allocation and Savings Rates for Long-term Goals
We have talked about this before and will continue to talk about it because of its importance: the key to investment success is reliant on your personal savings rate and how you allocate your savings between the stock market, the bond market, real estate, cash, and alternative investment options. It is a trade off – take less risk of a major drawdown during a bear market for less than the maximum return you may get from a pure stock market allocation. There are many reasons for this, but the two most compelling are steadier returns and the reality that sitting through a 20% 30% or 40% loss in value is not something most of us can handle. It is easy to want to get “the market” when the market is rising. On the other hand, we have yet to have a client complain that they didn’t get “the market” during a bear market like 2000-2002 or 2008. Strange.
The other piece of the success puzzle is savings. The more you can save when you are young, the better off you should be when you are hitting retirement age. Compounding – the growth process for an asset over time – is a hard concept for many people to visualize as compounding isn’t linear (1,2,3,4), but exponential (1,2,4,8). It takes time for it to work.
We bring this friendly reminder as we enter what may be a time of transition politically for the United States. The worst reason to make a change to your savings rate or asset allocation is because you disagree politically with whomever the resident of 1600 Pennsylvania Ave. is on January 21, 2021.
Good reasons to change your allocation would be you got a new job; you sold your business; or you retired. Politics is a (really) bad reason.
Same goes for your savings rate. We believe it is OK to lower your savings rate if you have a major change in life that forces you to save less for a period of time. Also, OK to stop saving when you stop working. On the other hand, we do not advocate dropping your savings rate because stocks are having a bad year. In fact, when the stock market is down it is a great time to ADD ADDITIONAL SAVINGS – you know, the old buy low sell high mantra.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. Magellan Financial, Inc. is a separate entity from WFAFN.
Investment and Insurance Products:
|NOT FDIC-Insured||NO Bank Guarantee||MAY Lose Value|
Jonathan D. Soden, Managing Partner Jon.Soden@wfafinet.com
Jeffrey T. Bogert, Partner
Robert I Cahill, Partner Rob.Cahill@wfafinet.com
Robert Sweeney, Financial Advisor Bob.Sweeney@wfafinet.com
Jay Knight, Associate Financial Advisor Jay.Knight@wfafinet.com