Tag Archives: financial advisor

3Q 2020 Update

The 3rd quarter of 2020 is in the books. The S&P 500 total return for the 3 months was 8.47%, including the -3.92% decline in September.

With only 5 weeks until the election, at least that source of uncertainty will be resolved. I do not think it makes a great deal of difference to the markets which candidate wins. Of the Democrats’ proposed tax increases, only the corporate rate will affect investors earning under $400,000 per year. Even then, Democrats might not be too keen on raising rates too soon in a shaky economy.

The better news is that the economy is not the same as the stock market. The economy is what is happening now. The stock market is built on earnings expectations. Perhaps the bigger issue that will drive stock market expectations is when and how the COVID issue will be resolved.

The optimism that drove the S&P 500 to 3,500 was not sustainable in the absence of a vaccine. However, earnings, the prospect for additional stimulus, and economic data continue to support the S&P 500 near the recent lows near 3,200. I look for earnings and accommodative Fed policy to support valuations, and COVID resolution to catalyze the continued reopening of the economy into 2021. That should support further earnings and market gains.

Halftime 2020, at Last!

As I suggested last quarter, the market has responded positively to a better understanding of Covid-19 and how to treat it. Political polarization, on the other hand, is likely to only increase into the election this fall. Social unrest is a problem, but rioting has given way to more rational discussions of legitimate issues.

 Despite the upheaval, the S&P 500 is only -4.04% YTD, and that is from a level that might be considered 5% overvalued by the Morningstar indicator.

In terms of the Morningstar market valuation indicator, the market ranged from 78% of fair value on April 1, to 5% overvalued on June 8. We finished the quarter 1% undervalued. Recovery has been driven by Government stimulus, business reopening, progress in controlling the virus, and hope for a vaccine. As we open the 3rd quarter, only the Government stimulus remains as a tailwind.

Near term, the market does not seem to have a lot of upside until we have a Covid-19 vaccine. The market anticipates a vaccine by early 2021. Although the market may pop on headline vaccine news, a development that could cause a sustainable rally is likely to me months off. Beyond that, we need to reckon with the 600-pound gorilla at the end of the vaccine tunnel: the election. While most administrations take more credit than they deserve regarding market movements, the current polarization could have a major adverse impact if the Democrats win both the Presidency and the Senate, opening the door to a progressive tax, spending, and anti-business policy in general.

So which direction do I think the market will move next? Last quarter I suggested, “we should see better than average returns in the not-too-distant future.” Now, however, I am less inclined to speculate about the short-term given the range of possibilities and the lack of near-term earnings visibility. Longer-term, the trend is still up. Earnings are almost certain to improve as business and employment normalize post-pandemic. The real question surrounds the rate of growth.

Cross-Currents

The cross-currents of economic data are all over the place. The good news is that there is no clear indication of a recession. More specifically, indications are that the economy will continue in slow-growth mode of around 2%.

Personal consumption is about 70% of GDP and is currently the strongest component. Business investment and labor force growth are the keys to productivity, and this is the more worrisome factor. Political uncertainty discourages capital investment. Workers need better tools if they are to increase output. Labor supply, on the other hand, is constrained by birth rates, demographics, and immigration policy.

Trade war issues are contributing to weakness in manufacturing. While that could spill over into other areas, the weakness appears to be within the bounds of normal volatility. The best news on the trade front is that the pain does not discriminate. There are no winners. Consequently, trade wars are generally short-lived. The bad news is that neither China nor the U.S. has much incentive to compromise before the next Presidential election.

Finally, the Fed has worked itself into a position that raising interest rates appears to cause the stock market to decline. That’s logical since interest rates factor into stock valuation. However, the real issue is whether higher rates would dampen economic activity. I believe higher rates would be healthy and lead to a stronger economy. Any economic activity that would cease due to a 4 or 5% interest rate is probably an inefficient or unwise use of resources anyway. Getting to higher rates will cause market tantrums, but the end is nothing to fear.

What Volatility Looks Like

It is hard to fathom the sway in sentiment from yesterday to today. Yesterday markets soared despite Biogen’s dismal news about a failed clinical trial that caused it to drop about 29%. Markets closed up strongly (S&P 500 +1.09%). Market analysts attributed the broad market strength to investors getting more comfortable with the Fed’s dovish stance.

Today, alarm bells went off because the yield curve inverted. This shouldn’t surprise anyone. The curve has been flattening for a while. The gap between the 3-month and 10-years yields is viewed as a leading indicator. It will be important to see if the inversion persists. The indicator’s success rate as a recession predictor increases when the inversion lasts more than 10 days. This is day 1. That was enough to send the S&P 500 back down -1.9%.

At the end of the day, there is no material, fundamental change. Sentiment changed, and that creates volatility.

Investing involves risk, including possible loss of principal. Past performance is not a guarantee of future returns.

And Now a Word from Our Sponsor

I was watching CNBC with the sound muted when I noticed an interview. I saw a woman and the graphic, 30 Years of Industry Experience. Wow! That’s all CNBC can say about their distinguished guest? While experience is necessary, it is hardly sufficient. One might expect something more substantive. It’s true that I only have 25 years of industry experience, so what do I know?

I know that the length of time I’ve been a financial advisor says very little about me. In my case, I think the 13 years as a financial analyst, before the last 25 years in financial services, was far more influential in my professional development. The role of a financial analyst is that of a paid devil’s advocate.

A corporate financial analyst is a gatekeeper. Any advocate in a company promoting a project or strategy that requires investment needs to demonstrate the financial effects of the idea to management. That requires a financial analysis of the project to determine the net present value and internal rate of return based on projected investment and the resulting cash flows. The financial analyst must be sold on the assumptions that will drive his models. Garbage-in, garbage-out.

The analyst must drill into the underlying data to verify everything. The marketing, engineering, and new product folks become emotionally invested in their ideas. The analyst must vet the projects as the gatekeeper to funding and balance the interests of zealous advocates against the numbers.

I view investing like project analysis. They both need to pass the expected return on investment hurdles and scrutiny of the underlying assumptions.

Many financial advisors, in fact, the most successful ones in my experience, are successful because they are well-connected and are great relationship managers. They impress, like any good salesman.

Who’s watching your wallet?

An autobiographical perspective from Robert Higgins