A Historic Market Recovery

Dear Friends,

We hope that this letter finds you safe and healthy during these still-unprecedented times.

2020 continues to be one of the most unpredictable years in memory. In the third quarter, markets rose to new all-time highs and to extreme valuations despite a resurgence in coronavirus cases. Stocks rallied thanks to a combination of even more accommodative Fed policy, hopes for a COVID-19 vaccine and a stronger-than-expected economic rebound even despite many industries suffering severe downturns from 2019 levels. 

September provided a reminder that the macro-economic outlook remains uncertain and markets can still quickly become volatile. First, it became evident that there would be no new economic stimulus bill in September, as both Democrats and Republicans remained far apart in negotiations. Second, economic data began to imply a “plateau” in the economic recovery. Finally, late in the month, coronavirus cases surged in Europe and began to move higher again in certain U.S. states, prompting concern regarding a possible return to higher levels of economic lockdown in Europe and the U.S. The S&P 500 declined modestly in September but remained positive for the third quarter.  

Markets and the economy have staged a historic rebound since the late March lows, and while we all welcome this impressive comeback, we enter the final quarter of the year keenly aware that some of the biggest unknowns for the markets and the economy may be resolved positively or negatively in the next three months.

Starting with the obvious, November 3rd is Election Day.  Beyond the most important question, “Who will win the Presidency?”, markets are also focused on whether the Democrats will win the Senate or if Republicans will be able hold the majority.  If Biden wins and Democrats control both the legislative and executive branches of government, then many economic policies will likely change, a scenario dubbed the “Blue Wave” by the financial media. If Trump wins and Republicans continue to control the Senate, then current policies and trends will likely continue. This uncertainty is causing some volatility in the markets.  

However, any near-term volatility is likely small compared to the worst-case scenario for the election, namely that there is no clear winner by the end of Election Day and the election becomes contested. The result is that the entire country could be be dragged through a situation worse than the Bush vs. Gore contested Florida outcome in the early 2000 election. If a stalemate occurs on November 3rd, 2020, we should expect significant short-term market volatility until a winner is declared.  

Investors would do well not to focus too much on the short-term impact and volatility regarding elections. Instead, it is helpful to look back at history to gain perspective. History shows us that although the immediate weeks and months leading up to and after elections tend to be volatile, over the long-run (and even over most 4-year terms), stock market performance is primarily driven by corporate profits and economic growth, not politicians (in spite of what they would like you to believe!).  As a visual aid, this chart shows the performance of the stock market going back to 1929 through a variety of Republican (red) and Democratic (blue) Presidencies, which demonstrates the point that throughout history, the market tends to do what it does, regardless of who is in the White House: 

Source: Dimensional Fund Advisors

Unfortunately, the election is not the only source of potential uncertainty and volatility coming in the next three months. Hopes for a COVID-19 vaccine have helped stocks rally to current levels, and there are now three separate vaccines undergoing final Phase III trials. Those trials will likely reach their conclusion in the coming weeks, perhaps before the election. If those trials fail to produce a viable vaccine candidate, that will likely create additional volatility as markets are expecting widespread COVID-19 vaccine distribution by early to mid-2021.  

As a third consideration, by the end of the fourth quarter, investors should learn the fate of the stimulus bill currently stuck in Congress. There’s near-universal agreement the economy could use more stimulus, but the politics of the election, combined with Republican and Democrat differences about how much money should be spent and where that money should go, have prevented stimulus from being passed and delivered to the U.S. economy. Markets expect a stimulus bill to pass by year-end, and if that fails to materialize, it will create weakness in one of the fundamental pillars of this recovery.  

Finally, the resiliency of the U.S. economy and markets is both admirable and encouraging. The recovery from the worst pandemic in 100 years has been nothing short of extraordinary. But the markets must decide whether they will be valued based on actual economic and business data or based on sentiment and emotion. It is hard to justify current stock market valuations relative to corporate earnings. The S&P 500 P/E ratio currently stands at 22.22, down from 23.16 last quarter and up from 21.09 one year ago. This is 5.34% higher than one year ago, pre-COVID, when the economy was setting records for the lowest unemployment in history, the highest corporate earnings in history, low inflation, low interest rates and many other positives. Mathematically, it is hard to make a case for the current market valuations except for lower interest rates than a year ago. It seems that current market valuations are being driven by emotion and sentiment rather than rational analysis of the state of our economy and businesses. Yes, there are some winners because of COVID-19, but have the markets factored in the actual damage to our economy and businesses that will become apparent once stimulus and artificial support is reduced?  

Earlier this year we made the decision to reduce risk in our portfolios.  You will never see us going 100% to cash or 100% into stocks since we do not believe market timing strategies are successful over the long-term. However, there are times when we feel that it is appropriate to play offense or defense, by overweighting or underweighting stocks.  As the market has continued to rally, a common question has been whether we still feel comfortable with this more defensive approach?  The short answer is yes. Most of our clients are income oriented, retired or close to retirement. As such, preservation of principle and avoiding major losses is a high priority.  A defensive strategy naturally smooths out market volatility by leveling the peaks and filling in the valleys. In a rising market this strategy accepts that some upward opportunity might be missed temporarily but will be successful in the long run due to the minimization of losses during down markets.  Every investor needs to balance the risk of losing money with the risk of missing out on opportunity.  As we offered earlier this year when making the announcement of our re-allocation, if you wish to revert to a more aggressive portfolio position, please give us a call and we will be happy to accommodate your desires. 

We are carefully watching and awaiting the outcome of the election to evaluate the markets initial reaction and we will make appropriate changes at that time.  Most likely, we will begin by dripping money slowly back into stocks in the coming 6 months if we see continued positive trends in economic data and corporate earnings and hopefully more reasonable stock valuations.  However, we must remain cautious that we do not chase stocks because of a fear of missing out (FOMO) even when the data tells us that stocks remain among their most expensive in the history of the markets.  We must acknowledge that psychologically driven volatility is an inherent characteristic of all asset markets. Is the market fairly priced or does Irrational Exuberance remain is as relevant as ever? 

Thank you for your ongoing confidence and trust. Rest assured that our entire team will remain dedicated to helping you successfully navigate this market environment.  If you would like to book a time on our calendars to review your accounts, then you can give us a call at 518 406 5624 or book online with a few easy clicks at the following link:  https://simmonscapitalgroup.as.me/

Sincerely,

Donald E. Simmons, CFP
Executive Director

Darren J. Leader, CFA
Director of Research

Audra K. Higgins
Chief Operations and Compliance Officer