October 2020
Key takeaways
► US stocks positive for the year
► Improving economy
► Need for more stimulus
► What to do about bonds?
► Election getting closer
US Stocks Turn Positive
Stocks continued their rally into the third quarter, setting records and turning positive for the year. The S & P 500 gained 8.93% during the quarter, despite a significant pullback of almost 10% in September. Notwithstanding the pandemic and slow economy, investors keep piling into stocks that are either immune to our problems or thrive because of them. What pandemic, they say? You will recognize today’s hot lifestyle trends in these stocks. Look at their year-to-date returns:
- Zoom Video (video conferencing): + 590.9%
- Tesla Inc. (electric vehicles): +412.8%
- Quidel Corp (rapid diagnostic testing): +257.6%
- Etsy Inc (handmade and vintage goods): +174.6%
- Amazon (e-commerce, cloud computing): + 70.4%
We will see if these trends continue. With paltry bond yields and many industries in decline, investors are sticking with the winners and betting that they will continue to go higher. However, these winning stocks are not cheap, and it may be time to explore value in other areas of the market, like small-cap stocks and international stocks. Like in so many different areas of life these days, it seems like we are experiencing a monumental shift in how we work, shop, and play, and it is reflected in the stock market.
An Improving Economy – for some
We often read about the doom and gloom in the economy, but the reality is that things are improving – rapidly. The unemployment rate dropped from a high of 14.7% in April to 7.9% in September. Retail sales rose 0.6% in August – the third straight increase in a row. ISM manufacturing PMI fell to 55.4 in September from 56 in August but still the fourth consecutive month of expansion in factory activity. Even inflation is ticking up. The annual inflation rate is 1.3% for the 12 months ended August compared to 1.0% previously.
However, not all Americans are feeling it. A divide between haves and have-nots is emerging. A “tale of two cities” seems to be forming where those who could keep their jobs without skipping a beat (working from home, for example) have done quite well. These folks have been able to pay off debt and save. US consumers built up an astounding $12.5 trillion in excess savings from April through July, according to new research by Morgan Stanley economist Ellen Zentner. They could not travel or eat out, so cash filled the banks. Others who work(ed) in hard-hit sectors like travel, restaurant, and entertainment continue to suffer. As of September 2020, the leisure and hospitality industry had the highest unemployment rate in the United States, at 19 percent. In comparison, workers in the government experienced the lowest unemployment rate, at 4.1 percent. The average for all industries was 7.7 percent. You often hear of a “K-shaped” recovery: Some continue to do better as others languish.
Need for More Stimulus
In addition to the Fed’s extraordinary efforts, you can point to the numerous stimulus and relief packages to thank for our economy’s present state. But more is needed. The Federal Reserve has injected trillions into the economy through various programs to calm markets and aid states and municipalities and companies. Their efforts to stabilize the economy include money market intervention, unlimited bond-buying (including high yield debt), and lending facilities to larger companies out of reach of the Small Business Administration. The Fed stated at numerous times that it is ready to keep doing its part. On the other hand, the White House and Senate are fighting with the House about the next relief package’s size and details. The four stimulus packages that have so far passed have totaled over $3.3 trillion – an incredible amount. Please note, according to data from the Congressional Research Service, America’s final bill for World War II cost $4.1 trillion in today’s dollars. Some aid, for example, supplemental unemployment benefits ($600 per week) and grants and loans to the airlines have expired. The Fed and many economists insist that more aid is needed to sustain this recovery, as there are signs of slowing. Hopefully, Washington will come to some agreement soon.
Are bonds worth it?
Over my entire career, the classic “60/40” portfolio – 60% in stocks + 40% in bonds – was the starting point for clients’ investments. Adjustments would be made to accommodate age, risk, and time horizon. In a growing economy with low inflation, an investor could take the risk in his portfolio’s stock-side while enjoying safety and income on the bond-side. Stocks and bonds would often offset each other – like a teeter-totter (seesaw) on a children’s playground. A growing economy led to a rise in stocks and often inflation too. Bond yields rose, resulting in losses on the bond-side (bond prices move in the opposite direction of yields). The reverse would happen during recessions. Now bond yields are meager – around 0.70% on the 10-year US Treasury – and the Fed has signaled that it will keep rates low for a long time. Hence, from now on, bond prices may not move much and do not offer much income either. At these levels, bonds are very susceptible to a spike in inflation. Already most high-quality bonds sport negative yields: their nominal yield minus inflation is negative. High-quality bonds are still critical for protection (think ballast in a ship) but perhaps only in smaller quantities. What to do? One idea is to replace some bonds with dividend-paying stocks. The yield on the S & P 500 index is approximately 1.75%. You can do a little better with an active manager. You can also add real estate, international bonds, high yield bonds, and even master limited partnerships (MLPs). All these alternatives offer higher yields but are more volatile. The answer may lie in carving out some high-quality bonds and splitting your risk between cash and some higher-yielding options. The portfolio may be more volatile but result in higher real returns long-term.
Election looms
The election is a month away. President Trump’s chances at victory are much lower now than in February and getting worse by the day. There appears to be some relief in the market about a decisive win for Biden. The worst case would be a contested election that would drag along for weeks. Would Trump or Biden be better for stocks? Who knows? Every four years, we seem to debate whether a Democrat or Republican is better for the economy. This year it is the election process itself that we need to be sure of. We continue to monitor developments for impacts on your portfolio and potential adjustments.
Please let me know if you have any questions or concerns.
Sincerely,
Henry Gorecki, CFP®
HG Wealth Management LLC
10 S. Riverside Plaza, Suite 875
Chicago, IL 60606
312-474-6496
henry@hgwealthmanagement.com
