“For every complex problem there is an answer that is clear, simple and wrong.” – H.L. Mencken
To say that the year 2020 has been different is an understatement. To say that nothing has gone according to that well thought out plan we all had in mind in January, we think, is about right. A global pandemic has that effect on things. For better or worse the month of September is a 2020 outlier, with markets performing just as one would expect. Historically September is a bad month for stocks. Not wanting to disappoint that is exactly what we saw with all the equity indexes we follow losing value for the month. Bonds were down every so slightly as the CRB Commodities Index lost 2.54%. The US Dollar Index strengthened up this month, gaining 1.87% for the month.
U.S. & International Stock Index Returns
|Index September 2020 Year-to-Date|
|Dow Industrials (2.27%) (0.38%)|
|S&P 500 (4.25%) 8.34%|
|S&P 400 (Midcap) (3.16%) (6.62%)|
|S&P 600 (Small Cap) (4.26%) (11.99%)|
|MSCI World (3.64%) 4.11%|
|MSCI EAFE (7.74%) (1.18%)|
|Bloomberg Agg. Bond 6.79%|
|CRB Commodity Index (20.07%)|
|US Dollar Index (2.83%)|
All data as of 10/01/2020, 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.]
Every four years we have a presidential election in the United States, and every year we end up having conversations with clients and prospective clients regarding the political implications for the stock market. On occasion the questions move towards the value of the dollar or bond yields, but mainly people want to discuss “the market.”
Truth be told, earnings are the key to the stock market over time. Better earnings equals higher asset values, lower earnings equals lower asset values. Period. Stop.
That doesn’t mean, however, that emotions won’t get in the way in the short run. Four years ago many people sold equity positions in the leadup to the 2016 elections because they were afraid of what the consequences would be for the stock market. Keep in mind it was a bipartisan effort.
Positive emotions lead to enthusiastic buying, reminiscent of some great years for the stock market investor. Think 1996 to 1999 or, more recently, 2019. On the other side of the coin, unusual pessimism can lead to periods of losses. Sometimes these periods are short lived, like the fourth quarter of 2018. Other times they are more sustained, like the aftermath of the excesses of the 1990s and the three-year bear market of 2000-2002.
In the end, the stock market has continued to move higher since the last election due to S&P 500 earnings increasing more than 52% from $106.26 in 2016 to $162.35 for 2019.
Where are the Markets Now?
Heading into October the market looks better than it feels. Put another way, the correction experienced in September looks like a correction in the uptrend and not a change in market direction. Looking at Chart #1(S&P 500) and Chart #2 (NASDAQ) we see two market indexes that have been trending higher since the market bottom in March. Both, in our opinion, were set up for a normal correction for two reasons. First, there was an acceleration in the rate of increase in the final two weeks of August. Coupled with this is the historically tough month of September.
Importantly, the downturn for both were relatively tame. Technically, the 50 day moving average (50DMA) for both indices were temporarily breached, but the longer-term 200 day moving average (200DMA) was not. From a technical perspective this is very positive as the 200DMA is what many analysis view as a key indicator for the overall market trend. When above the 200DMA the trend is higher; When below the trend is considered to be lower.
Chart #3 is the yield on the 10-year US Treasury bond. After a massive move down that coincided with the economic lockdown in March yields have started to slowly trend higher (not high, but higher). While we view this as positive, we must not that short-term rates have been pegged at close to zero. According to Fed Chairman Powell, short rates will continue at this level through 2023. In our judgement, long rates can move higher, but only so far in such a scenario. We see 10-year Treasury rates having the capability to get back above 1%, but would be surprised if they get above 1.4% without a change in interest rate policy at The Federal Reserve Bank.
Chart #4 illustrates the uptrend in gold. After almost 10 years of sideways pricing, gold started moving higher in 2019. For the past few months, the price has consolidated at levels below the all-time highs. In our view this is constructive. Given the current financial stimulus being provided by central banks across the globe we would be surprised to see the current consolidation turn into the end of the gold bull market.
Where do the Markets Go from Here?
Like we stated earlier, the stock market will move in the short term based off of emotions, but over the long-term prices are determined by earnings (and expected future earnings power). Thus, looking ahead, we need to consider where the market is on an emotional basis as well as where earnings may be heading. So, let’s dig in …
As we write this in early October the overall sentiment of the market appears to be a bit unsettled. September was a down month for stock market investors and we are just weeks away from the 2020 presidential election. There is always a lot going on during an election year. This year – given the pandemic, stimulus talk, economic stress – the agenda appears to be fuller than usual. Unsettled markets tend to be volatile markets. And for those who may be unaware, the work “volatile” is code used on The Street for down markets.
Yet, here’s the thing. As many people focus in on what is happening in the economy in the world around them, that is not necessarily what affects stock prices. Areas of the market that have been either unaffected by, or have benefited from, the pandemic, are large part of the three major indexes – The DJIA, S&P500, and NASDAQ. Think technology, health care, and big retailers. Related to this point is that the areas most affected by the pandemic so far are a relatively small part of the indexes. Think movie theaters, cruise lines, commercial airlines. Plus, your favorite locally owned restaurant doesn’t trade on an exchange.
There is also an unbelievable amount of fiscal and monetary stimulus still in the system, with the possibility of more to come either before the election or shortly thereafter. The Fed’s balance sheet is up 69% this year from $4 trillion and now stands at $7 trillion. This matters. The money created needs a place to go.
The stock market has been a beneficiary of the largess and, in our opinion, is likely to continue to benefit if Congress and the President strike a deal for more economic stimulus.
Looking a bit further out – the next 9 – 18 months – we do have cause for concern. As the subsequent chart from the US Bureau of Labor Statistics shows, the unemployment rate spiked up to around 15% with the shutdown in the economy and currently hovers in the area of 7.9%. On the surface all seems to be moving in a solid direction. But … we are not so sure.
Right now there are more than 9 million more people unemployed than there were a year ago with the number of permanent job losers still increasing. As is the number of those unemployed more than 26 weeks. (Source) For the past six week the new unemployment claims have based between 800,000 and 900,000. For perspective, the peak weekly unemployment claims during the great recession were well below these levels.
Which brings us back to the current dislocation between the stock market and the current economy on the ground. The jobs data is telling a story of a duel economy where there are certain sectors of the economy that are doing fine while other suffer. Many people are back to work, while many are not. Some employers are now just starting to lay off workers as their PPP money is no longer supporting their businesses. Some are finding out that what they thought was a temporary furlough has turned into a job loss and need to find a new job. We are at what appears to be a sticking point for many Americans.
And this is where the clear, simple message gets swallowed up by the complex reality of the current situation. Up to this point there has been fiscal support for those of us who have suffered the most economically from the pandemic. As of right now, that support is gone and there is no guarantee believe it is coming back. With the low hanging fruit of the job market already picked, Federal support for the unemployed gone, unemployment claims stuck at historically high levels, and more Americans entering the long-term unemployed category, it is hard to see a way for consumer spending to remain stable. In such an environment we find it hard to believe corporate earnings will move higher, let alone get back to the 2019 peak.
While we believe there is reason for optimism for a Coronavirus vaccine in the future, we see it is a solution that will get the economy back working “normal” by 2022, not January 2021. The recent positive findings on antibody solutions is a very good start. But until we have a proven vaccine that is distributed to a large part of the population it is hard to imagine going to a Springsteen concert or a Phillies game.
Our concern is that what is happening in the local economies will start to hold back earnings for Corporate America in the coming quarters, limiting the upside for the equity markets. And as history reminds us, stock markets move on emotions in the short term but on earnings in the long term.
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.
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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