The Quick Summary:
1) The election is over, but uncertainty remains high.
2) COVID-19 is resurging in the US and Europe.
3) Economic growth and corporate earnings recovered in the third quarter, but fourth quarter is increasingly a question mark.
4) Interest rates and equity markets are at the upper end of their recent ranges since the end of March.
5) There is slightly more visibility for a smaller fiscal package.
6) Recent vaccine data was perceived by markets as a significant positive.
7) Our asset allocation portfolios remain conservatively positioned.
The S&P 500 rose near its all-time high from September but sank in the latter half of the month. October started off on the right foot, continuing its recovery from the -9.5% September sell-off, and rising +5.2% in the first two weeks of the month. But it then sold off again by -7.4%, and ended the month down -2.7%, just +1.2% above the September low. Value outperformed growth for the month (and fairly consistently throughout) in what was a potentially sustainable rotation. The NASDAQ 100 (the “QQQ’s”), heavily weighted in large cap technology names, was down -3.0% for the month. US small capitalization stocks outperformed large, up +2.1% for the month, with the Russell 2000 value up +3.5% and the Russell 2000 growth up +0.8%. Emerging markets were strong as well, with the MSCI Emerging Markets index up +2.1%, driven by China, which was up +4.8%. This was in contrast with developed non-US markets which declined -3.9%, driven by Germany (down -9.8%) and the UK (down -4.5%).
The 10-year US Treasury yield, however, climbed higher and stayed there. Bonds did not provide protection as the large cap equity markets fell. The yield began the month at 0.68% and ended at 0.86%, close to the high end of its 0.50% to 0.88% trading range since the beginning of April. The yield curve, as measured by the 10-2 year spread, steepened meaningfully in October and closed the month at 70 bps, nudging above recent highs to a level it has not seen since 2018. Inflation expectations remained subdued, however. Gold was flat but oil declined by -11.0%. Although the US dollar, as measured by the ICE Dollar Index, ended the month almost exactly where it began, it ended on a rising note. Volatility (as measured by the Cboe Volatility Index or VIX), on the other hand, accelerated from its post-COVID low of 21.4 to close the month at 38.0, with a nice little spike in the last week. Taking all these market moves together, the set up into the post-election and the remainder of 2020 is for a wide range of scenarios and investment implications.
The virus resurged to new records in Europe and the US. It happened alarmingly fast. Europe’s new cases swept past the US’s, then cases in the US accelerated. European coronavirus infections topped 200,000 at the end of October after doubling in just 10 days. Hospitalizations in Europe are skyrocketing, with about 75% of Germany’s ICU beds occupied. French President Macron warned ICU patients in France could reach 9,000 in two weeks. Belgium and Switzerland also predict hospitals may reach capacity in a week or two. The US reported a record high 99,300 infections on October 30th and cases grew by 5% or more in 43 states, while the seven-day average of new cases surged almost 25% over the last week of October to a record high of more than 78,000. The seven-day average of hospitalizations also hit a record high in 18 states.
Lockdowns are back on the table. Ireland, the UK, France, and Germany announced new lockdowns for the entire month of November with most focusing on bars, restaurants and non-essential retail. The UK went to full national lockdown though, saying people must stay at home unless they have a specific reason to leave. Spain declared a six-month state of emergency with tighter containment measures. Greece, Belgium, and Austria were among the other countries that have also implemented new lockdown measures. The White House is not considering federal mandates, but New York state announced that it will require visitors from most of the country to test negative for the coronavirus and quarantine for three days after entry before taking a second test on the fourth day. The Governor of New Jersey warned that he won’t rule out another lockdown to stem the rise in coronavirus cases.
The announcement that the coronavirus vaccine candidate from Pfizer and BioNTech was more than 90% effective in late-stage trials generated considerable excitement but there are still a number of issues to be sorted out. Several other vaccine trials are also close to reporting information on the extent of their effectiveness, and hopes are high. But the trip to wellness does not look like it will be a smooth one. Reinfection has been documented and antibodies have been shown in some cases to dwindle or disappear in just a few months. While vaccine optimism remains elevated, ending the pandemic may not be quick or easy given the logistical, production and public education challenges of immunizing 60-70% of population. Some vaccines may not prevent infection, but rather reduce symptoms, and might not work for everyone or for long.
Economic and earnings reports have been better than expected, but the new virus and lockdown data puts the focus on what happens next. US 3Q GDP was reported at +33.1% SAAR, above estimates of 30.9%, which had recently been raised. This was the snap-back from the record 2Q decline of -31.4% SAAR. However, GDP is still down -3.5% y/y. The US unemployment rate was reported at 7.9% for September, lower than the consensus estimate, and another improvement from the prior month. But labor force participation declined, and permanent job losses crept up 345K to 3.8M. In addition, employment is approaching another cliff on the horizon with a 31-Dec deadline when several key federal jobless programs established under the CARES Act in March will end completely. If Congress does not pass new stimulus legislation, more than half of those receiving unemployment benefits (≈13.4M people) will be left without income.
Eurozone 3Q GDP growth also surprised to the upside with a +12.7% rebound, much stronger than the +9.4% consensus and an -11.8% drop in 2Q. However, Eurozone GDP is still down -4.3% y/y. On the heels of this report, though, fresh lockdowns across Europe triggered downgrades in the economic growth outlook. The Eurozone economy is now expected to shrink in the neighborhood of ≈ -2% in Q4. Most economists had previously forecast positive growth.
We are over halfway through earnings season in the US with an unusually high percentage of reports beating the consensus and by unusually high percentages. According to FactSet, more than 85% of companies that had reported as of October 30 have surpassed consensus EPS expectations, well above the 73% one- and five-year averages. In aggregate, companies are reporting earnings nearly 19% above expectations, much better than the 8.0% and 5.6% one- and five-year average positive surprise rates. The response to these big surprises, however, was greeted with a mixed stock market reaction. Some companies went up after weak reports and some went down after strong reports, but there was lot of vice versa too. Earnings reporting season began unofficially on October 12th and the S&P 500 registered a decline of -7.4% from then through October 30. There was not a particularly consistent qualitative theme overall for winners versus losers.
Now that that’s over…Election Day has come and gone, finally, but uncertainty persists. Control of the Senate will not be decided until the Georgia run-offs for two seats are finalized on January 5th. If the Republican candidates win at least one of the seats, the Republican Party will maintain control of the Senate. If the Democratic Party wins both seats, it will be a 50-50 tie, with the tie-breaking vote held by the Vice President. Importantly, Senator Joe Machin (D, WV) has publicly stated that he, at least, will not vote in favor of nixing the filibuster or expanding the Supreme Court, two key political issues, highlighting that the final form of many legislative issues remains highly uncertain. In addition, the Democrat’s majority in the house was maintained, but reduced.
President Trump has accused the Democrats of perpetuating a fraud on the American public by stealing the election—allegations which many consider unsubstantiated and which have been rebuffed by Democratic and Republican Secretaries of State. The President further stated he will pursue this issue via the Supreme Court (whatever vague meaning that has) if necessary. He has refused to concede the election to President-elect Biden and leading Republicans have coalesced around his strategy. In addition, Attorney General Barr authorized US attorneys to investigate alleged voter fraud. To be successful, however, results in several states must be overturned to beat Biden, but his legal challenges are not contesting enough votes to win. The main effect in the meantime appears as an attempt to hamper an orderly and efficient transition of administrations at a time when there are many crucial issues which must be attended to as quickly as possible. The Biden transition team is considering legal action to force the General Services Administration to designate him the winner so that it can begin accessing federal resources needed to ensure an orderly transfer of power.
Fiscal stimulus, COVID-19, the economic path going forward, and the direction of the value of the US dollar are still the keys. Once the composition of the Senate has been put to bed, the usual issues will reclaim the spotlight. What the new governmental configuration will be able to accomplish with regard to fiscal stimulus (and how quickly) will still be open questions, but the visibility and confidence level in the outcome will be somewhat improved. Additional stimulus is almost guaranteed, but how much and what kind is still very uncertain. How much more stimulus feeds into how much more debt and how much more monetization (also known as “money printing”), which, when considered in the context of those same items in the world’s other economies, feeds into which way the dollar goes. This, in turn, influences the direction of US stocks and the growth and value trade. So far in 2020, a weaker dollar has been a tailwind for the equity market in general and growth stocks in particular.
The Northern Hemisphere’s first winter COVID experience is off to an unsettling start. Hospital capacity, therapeutics, and lockdowns will be critical to employment, business sustainability and economic and corporate earnings growth in the shorter run. A successful vaccine rollout will likely be important in determining if 2021 is a good year or a bad year. Notwithstanding the Pfizer announcement, this is in no way a settled issue.
The crowding and valuation extremes are still present and are still risks. Notwithstanding the October rotation to value and the post-Pfizer announcement big-time continuation of the same, there are still a lot of thumbs on the growth and technology side of the scale, so the sustainability of this rotation is also not a foregone conclusion. There are a lot of thumbs on the interest rate scale as well, with the many thumbs of market participants on one side and the big thumbs of the central banks on the other. The yield on the 10-year US Treasury had worked its way all the way up to 0.94% on election day before results started coming in but then violently retreated to 0.76% the next day. It has since moved back up and has approached the 1.0% level. Volatility of this sort is not a good set up for trying to time the markets or for making outsized positioning bets.
We continue using a broad array of tools at our disposal to monitor the environment for possible changes to the positioning of our strategies. Fundamentals at the macro and company/industry level on quantitative and qualitative bases. Technicals throughout the markets. We consider many scenarios and their potential implications and make judgements based on the weight of the evidence.
We favor being conservative, emphasizing quality and diversification in this environment. Taking measured, thoughtful and prudent steps, and keeping positioning away from extremes is the best way to manage uncertainty. Our positioning had been increasingly conservative prior to the abrupt change brought about by COVID-19 and has become more conservative since. Our strategies are now positioned with almost no exposure to credit, and lower and more style-neutral levels of equities. We retain a significant exposure to gold. Our fixed income duration is neutral excluding cash, but we are overweight cash. We expect to remain conservative and measured in our positioning and look to execute on additional asymmetric risk/reward opportunities as they arise.
Source: FactSet’s StreetAccount – All information above (unless otherwise noted), to include dates, returns and performance is derived from the noted source.
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