Stocks experienced their second consecutive quarter of significant gains sustaining a historic recovery that few expected in March. This quarter saw the S&P 500 eclipse its previous all time high reached before the COVID market sell off. This is a remarkable feat, all things considering. The bear market experienced in March of this year was the fastest seen in history and we have just experienced the fastest recovery to all time highs. It has historically taken around 1,500 trading days for stocks to match their previous highs. It only took 126 trading days this time. While the S&P 500 retook its previous high, small-cap companies are still lagging. The Russell 2000 is about 10.8% from its late February high.

Stocks had a summer surge that saw the S&P 500 gain 12.6% during July and August. The rally was lifted by a strong run in the markets five largest companies (Apple, Microsoft, Amazon, Alphabet (Google), and Facebook). Apple rallied 41% during this two month period and the others gained between 10% and 23%. Several successful IPOs in the tech sector helped lift the market as well. Economic news released this summer proved to be better then expected, showing that the economic recovery is ahead of projections. The return of individual or retail investors also helped throw extra fuel on the rally. Retail investors have taken to the stock market during quarantine and this summer, some reports indicate they are accounting for 20% of the market trading activity. This is nearly double their 2010 activity levels, according to Bloomberg.

While the summer surge was welcome, September came and there was pull back from all time highs. Concerns that a second stimulus bill was not progressing through Congress and sector rotation lead to the move lower. Some investors sold or took profits in the tech shares that rallied so much this summer. The sell off in the technology sector is positive in our view because these stocks may have gotten ahead of themselves in their summer run up. At the end of the quarter, all sectors were positive apart from energy.

The Election

In our client meetings, the most common conversation topic is what is going to happen with the election. After 2016, we are not making any predictions! The expectation that this election will be contentious and many races won’t be determined on election night is something that the market is pricing in at this point. Investors have made bets that markets will see increased volatility (expectations of price swings) through the end of 2020. This is a signal that uncertainty is expected and priced in by investors. The move around elections is usually less than 3% to the positive or negative, with a lot of movement in between this range. Instead, we are looking past the election to see what the economy and corporate earnings will look like in 2021 and beyond. One thing that history has shown is the market returns to normalcy pretty quickly after an election. Ninety days after the election, stocks are up about 3.7% and are positive 75% of the time. Once election risk is removed, the market has historically rallied.

Investment Strategy

We remain positive on stocks over the long term. We are 98% invested with just a small allocation in cash that has built up. We anticipate putting that to work before the election if there is any market weakness. This summer, we reconfigured your international stock holdings. We increased our weighing by a few percent and split our allocation to invest in stocks with positive momentum and low volatility. Stocks that have momentum characteristics are stocks that have seen an increase in value over the past six to twelve months. Pairing this with a low volatility stock ETF offers a balance of strong returns with less risk.

Outlook

The Federal Reserve (Fed) has made it clear that they have no plans to raise interest rates until 2023 at the earliest. They also announced they will allow inflation to run higher than its target of 2.0% in an attempt to increase economic growth. Both of these are positive for stocks. Having interest lower for longer will allow stock market valuations to justify above average valuations. Additionally, if interest rates remain low, investors will be drawn to stocks seeking better return rates than safe-haven assets like cash or bonds.

Economic growth and corporate earnings are projected to stage a strong comeback in 2021. On the corporate earnings front, projections for the S&P 500 should have its operating earnings at or above 2019 levels next year. This would mean that earnings would grow 45% from the depressed 2020 numbers. Based on next year’s projections, the S&P 500 is trading around 20 times earnings. This is above average but given low interest rates, we think this is acceptable.

While we are optimistic about stocks, we are watching some areas which offer risks to the market. The COVID 19 virus still has a significant impact on day to day life around the world. The risk of a second wave is always present. The virus will continue to cause some unevenness in the economy until a vaccine is in place. There may be bumps during the recovery, but the upward trend for an economic recovery is clear. Individual investors returning to the market is something else that we are monitoring. When retail investors return in droves, it has often been an indication that markets may be reaching a peak. In 2020, retail investors rushed in during the March sell off and participated on the way up. We are not hearing a lot of people quitting their jobs to be day traders, but rather treating their accounts more like a fantasy sports account. We do not think this is a repeat of 1999.

The election season is going to be a contentious and emotional period. We are looking past the election and investing for the long term. We are optimistic that stocks will continue to perform well over in the coming year and plan to use any weakness to increase our holding in stocks.

Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

US Viewpoints: September 30, 2020