“For every complex problem there is an answer that is clear, simple and wrong.” – H.L. Mencken
“Have an opinion on what the market should do but don’t decide what the market will do.” – Bernard Baruch
When historians look back on the year 2020 it will most likely be viewed as a year of disruption as well as the unusual. For the markets we have seen disruption happen back in the Spring before a sudden turnaround that has continued through the first half of Summer. Equity markets were up again in July with the S&P 500 Index turning positive for the year. Bonds continue on their torrid pace gaining another 1.58% as commodities continue to rebound off the lows, with the index gaining more than 3% for the month. The big July loser? The US Dollar Index broke down with a 3.89% loss.
U.S. & International Stock Index Returns
|Index July 2020 Year-to-Date|
|Dow Industrials 2.56% (7.39%)|
|S&P 500 5.29% 1.25%|
|S&P 400 (Midcap) 3.91% (9.65%)|
|S&P 600 (Small Cap) 3.28% (15.26%)|
|MSCI World 4.37% (2.27%)|
|MSCI EAFE 1.95% (10.64%)|
|Bloomberg Agg. Bond 7.72%|
|CRB Commodity Index (22.66%)|
|US Dollar Index (2.71%)|
All data as of 08/01/2020, 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.]
Sometime You Get What You Least Expected
On January 1, 2020 we are fairly confident that there were very few people who were predicting that a global pandemic would wreak havoc across the globe. Yes, we know that researchers back in the stone age of 2007 attempted to warn us all of what we are currently living through, they weren’t pounding the table at the start of the year that the time was now. Once the virus became reality, there were pundits as well as rando Facebookers and Tweeters began saying some pretty outrageous things. We won’t bore you with the details, but you can find them here if you have an interest.
Putting aside conspiracy theories and some of the less well thought through predictions, we have witnessed a number of surprises on how the economy and markets have reacted to the current world situation. A US-based privately held bicycle-maker had planned for a drastic reduction in Spring sales, also known as the industry’s prime selling season. Who buys a bicycle when everyone is hunkered down at home? Much to the surprise of their advisors, a lot of people.
What was thought to be a bust of a year has turned into a boom for bike shops across the country. The expected dusty bike inventory started to flow out the door, creating a bike shortage. Old bicycles started to find their way out of the back corner of the garage into the bike shop for repair, thus causing shortages of bicycle components. Exactly what was the least expected outcome came to fruition.
The same can be said for the financial markets. After the fastest drop from all-time highs to a bear market for the Dow and the S&P500 during the month of March, the markets began to recover. That recovery, while a pleasant surprise in our opinion, has been a surprise none-the-less. As we write these words the S&P500 has not just recovered, but it has turned positive for the year! This at a time when unemployment is at extreme levels, the Federal Government is running monthly deficits that are larger than what used to be considered risky yearly deficits, and the pandemic has continued to spread. Did you have that on your 2020 bingo card? We didn’t.
How Did We Get Here?
One of our common themes we believe is that the financial TV pundits are a notoriously bad group to listen to for understanding of why the markets are acting in whatever manner they are acting at any given time. TV punditry is designed for simple answers to simple (or complex) questions. There are times when X happened because of Y but, in our experience, that is a rare occurrence. The two-sentence answer to “why did the stock market recover as quickly as it did” really needs to be replaced with much more depth and nuance. In fact, we would be shocked if there aren’t books written about this after all is said and done.
The simple answer is the US Government responded to the economic impact of COVID-19 with large doses of both fiscal and monetary policy. Individuals received $1,200 checks; The unemployed received an additional $600 per week in compensation above their state benefits; Small businesses were floated forgivable loans (as some large businesses also qualified); The Fed flooded the financial markets with liquidity. There’s more, but you should get the point.
Yet there is much more to the story. For example, day trading is back in vogue and turbo charged in comparison to what it was in the late-1990s. Back then you had rooms of traders. Today you can trade on your phone. And with “innovations” there are online trading platforms that allow you to trade fractional shares of stock, lowering the bar to become what we believe a stock market gambler … which speaking of gambling, in case you didn’t hear, but some of those who are traditional gamblers started trading stocks as there were no sporting events to place a bet on. Wish we were making this up.
There is so much more, like the currency markets, trade wars, etc. … but we won’t bore you with the details. Let’s just leave it as there’s no simple reason for the market turnaround.
So, What Exactly is Happening?
A lot actually. When most people talk about “the market” they are talking specifically about the stock market. When we say that there is a lot happening, we mean there’s a lot happening not just within the “stock market,” but within the other major financial markets – commodities, currencies, and bonds. Right now, we would argue, there is a lot of really important activity happening.
Looking at the chart of the S&P 500 (Chart #1), you can see that there was a gap down at the start of the ensuing bear market that has just very recently been filled. From a technical perspective this could be significant. With relative strength looking to produce a lower high (a negative divergence), leads us to believe further upside for stocks looks less likely in (at least) the near-term.
The rebound for stocks coincides with a drastic move lower for interest rates, a direct result of actions taken by The Federal Reserve Bank to combat the negative economic affects of the coronavirus. The result is 10-year Treasuries are now yielding at their lowest levels. Taking just a cursory look at Chart #2 the extent of the move in yields. Great for borrowers of all kinds, it is hard to make an argument that rates will continue to move lower.
Moving onto the US Dollar, we see a very real possibility that the multi-year strengthening of the dollar against other currencies is reversing itself. Chart #3 shows a possible lower high earlier this year that has been followed by general dollar weakness. What we find interesting is the dollar has not rallied higher as the trade rhetoric with China has started to ramp up again. If this is indeed a reversal in trend, we would expect it to be multiple years in duration and have implications for portfolios.
Finally, we have a chart of gold, which after 10 years has hit new all-time high levels, clearing $2000 per ounce for the first time. Silver, Platinum, and Palladium (not shown here) have also been trending higher.
That’s Just Great, but What Does This All Mean?
To answer in one sentence: Magellan Financial believes that we are in the beginnings of a change in the interrelationship of the markets that will have implications for investors over the coming years. Of course, as we argued a few paragraphs ago, a clear, simple answer to a complex problem like “where do I want to be invested “is not the right answer. The change, and where one wants to be invested at any given time, won’t be straightforward in our opinion. There are many variables that can and will change in the coming months and years that will change any simple answer to this question. We feel the better path to take is to talk through what we feel is probable, with a touch of the possible thrown in for fun.
The biggest change we see happening in the markets right now is the weakening of the dollar. When the dollar is strengthening it is usually a good idea to be underweight certain areas of the market, including but not limited to commodities, precious metals, multi-national stocks and emerging markets. Typical areas of strength with a strong dollar would include consumer cyclical stocks, US small and mid-caps and US Fixed income.
When the dollar weakens you can flip the script around for where you want to start looking for investment opportunities. All of a sudden multi-national corporations and foreign equities are more attractive. Commodities – priced in dollars – have a natural tailwind. With a weaker dollar the investment playing field takes on a new look.
Yet it is not that simple. You still need to invest in good companies and good areas of the world. If, for example, European stocks are having a bad year a weaker dollar will help mitigate the losses for a US-based investor, but it doesn’t automatically make it a solid investment. At the end of a day a bad investment won’t turn into the trade of the year just because of how the dollar is valued. We still need to make sound choices.
Added to the complexity is factors beyond the markets. In case you’ve been living under a rock without a tv or twitter feed, there’s a presidential election coming up in less than three months’ time. The policy landscape may be vastly different depending on the outcome of the election. To say they have different visions for the future of the country is a huge understatement. Implementation of those ideas depends not just on who occupies the Oval Office, but which party in in control of the US Senate.
What happens with trade is also a huge wildcard for investors. The relationship the US has with China is not in a good place right now, and is likely deteriorating as the US steps up the sanctions on Tic Tock after 2+ years of trade negotiations and tariffs. Keeping this focused on investing, how the growing rift between the two countries resolves itself can make a huge difference on where a portfolio should be invested. There’s a possibility everything gets resolved and the world sings Kumbaya, but that doesn’t feel probable. Nor does a cold war like the one with the former Soviet Union, given the much deeper economic ties between China and the US. Foreign Policy has a great reasoning behind the current tensions that can be found here.
While not the end, we will end this conversation with some thoughts on the globally low interest rate environment and income investing. For years (maybe a decade?) we have been talking about lower for longer when it comes to interest rates. We are old enough to remember when the 10-year Treasury had a coupon rate of 5%, not 50 basis points. Over the years we have heard those who argue that big government deficit spending will naturally lead to higher interest rates and inflation. That possibility has yet to turn into a reality. We get the logic, but we also look at Japan and see huge debt burdens, near-zero rates for 20+ years, and a lack of any inflation to speak of. More importantly, the near zero rates we are experiencing have made for a vastly different approach to income for retirement then we (Magellan Financial) have ever encountered. Higher rates are a possibility, but in our view not a probability.
Our Bottom-Line: Every era of investing comes to an end. We believe we are in the early days of a new day for investors. What worked over the previous 3-year, 5-year or 10-year period is not necessarily what will work in the coming years. Yes, innovative areas of the economy will continue to produce great companies and wealth opportunities. But where those opportunities come may not be the opportunities of the past. As we have done since our humble beginnings at Warren York and Associates, we will continue to look ahead for the best long-term investment opportunities for our clients.
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.
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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