I want to give a brief update on my views of the markets and my thoughts on the upcoming general election. My summary thoughts on the markets can be found on the table of contents of my quarterly themes book and also can be found on the Touchstone website, and you can see how all my dials seem to be converging on the center which I fear is suggesting a lack of conviction – but that is not my message. What I want to communicate is that as I look out at the marketplace I see a lot of asset classes, at least through the eyes of the indexes that in general have gotten ahead of the fundamentals.
But it is a mixed outlook. On the one hand we are starting a new cycle and kicking this cycle off has been an unprecedented amount of monetary and fiscal stimulus. Some of that stimulus went into hands that didn’t need it, so it has yet to be spent and there is still the potential for more stimulus. And as I look into 2021 the likelihood that social distancing starts to go away increases significantly – so you could have pent-up demand, stimulus money left to be spent, and a strong desire to get out of our basements and go shopping; all of those sort of conspiring to boost the economy. On the other hand we are starting this cycle at valuation levels that are typically associated with the end of a cycle. Even if I make adjustments and take out the first half of downturn and just substitute in 2019 earning per share or cash flow or revenues – it doesn’t matter what valuation measure I use, the S&P still looks expensive in a historical context. Which suggests with it we should bring down our longer term return expectations. But it doesn’t mean that I would under allocate to equities – especially now at the beginning of a new economic cycle and with a very accommodative Fed. Actually I like equities relative to fixed income.
Within equities I do see some pockets of opportunity both inside the S&P 500 and outside of it, but I think selectivity will be the key. There is a lot of bifurcation in the marketplace – the year-to-date move in the S&P 500 has been pretty narrow, but I don’t think that it is completely unsupported by fundamentals. If you sort the market by revenue growth in the first half and stock returns year-to-date you find a pretty strong linear relationship. Those companies with strong revenue growth did well – and they just happen to be the beneficiaries of social distancing and working from home. That’s going to unwind when social distancing goes away. It won’t completely unwind, but there is the opportunity for some of these more cyclical companies that have been hurt by social distancing to get a bid. Getting from here to there is probably going to be a little bit bumpy. Certainly the near term picture is clouded by the lack of another stimulus bill (we don’t know if that’s going to happen as I’m taping this) and the potential for a virus rebound as temperatures drop. The last stimulus bill was huge for the economy and for the markets. So as that expires the near-term risk for the market grows, but there is likely a better backdrop looking out year from now.
I think fixed income is even more difficult with interest rates on investment grade securities sitting near all-time lows. But it should continue to act as ballast in a portfolio and suppress equity volatility – it’s still will play an important function in your asset allocation. Like we saw in the last cycle these low yields are going to push investors out the risk spectrum to get additional yield and I think it makes sense to get ahead of that move.
With respect to the election, I recently put out a piece looking at what a Biden presidency might look like for the markets. In it I end up throwing a lot of water on this idea of being able to game the markets based on potential policy initiatives. I provide a number of historical examples. One recent one surrounds Obamacare – the narrative surrounding the passage of that bill was that it would hurt small business hiring as employee costs would jump up, the health care sector was expected to underperform, and inflation was expected to move up all due to the passage of this bill. Those all sounded like reasonable expectations, none of them panned out. There’s just many other factors that have to be considered – I provide a lot more examples in there as well. I do believe that Biden wins, but I’m basing that on polling data, and we know that can be wrong. I believe that the voter turnout is going to be very important – if the turnout is big then a democratic senate majority becomes more likely – if not then it is less clear – there are 5 senate races that are a toss-up. I’m not as concerned about a Biden presidency as others seem to be, but I’m not sure the market is going to really like either candidate given the starting place in terms of valuations if we look out four years from now.
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