It’s finally here.  The long awaited 2020 Election Day is upon us and the final election results and the eventual policy decisions may impact economy and the markets for years to come.  The markets seem to be a bit on edge as the pending election can still move us in a variety of directions.  Besides the election itself there are concerns of a contested election, a spike in COVID-19 cases, civil unrest, uncertain future fiscal stimulus and further shutdowns are all weighing on the markets this November.  This is a recipe for increased market volatility as investors try to put 2020 behind them.

While the pollsters and political prognosticators struggle to provide clarity to the election outcomes, the market itself has a long history of accurately forecasting presidential elections.  In the 23 presidential elections since 1928, 14 had U.S. stock market gains in the three months prior to the election. In 12 of those 14 instances, the incumbent party won the White House. In the nine elections preceded by a three-month stock market loss, the incumbents were replaced by the opposition party.  As always there are exceptions to the rule.  In 1956, 1968 and 1980, this theory did not hold.  Still, being correct 20 out of 23 times (87%) is a compelling success rate when it comes to the market’s ability to accurately forecast the presidential election. ¹

In the three months leading up to the 2020 election, the U.S. stock market as represented by the S&P 500 did post a meager gain of 0.37% after surviving a 5.6% decline in the last week of October.  Historically, the positive three-month return tells us President Trump will be re-elected to a second term.  In this upside-down year, anything is still possible.  Be prepared to expect the unexpected. ²

Lost in all the political headlines was news that the U.S. economy was continuing its comeback.  The most impressive number released in October was third quarter GDP which showed a record 33.1% annual growth rate.  Granted this announcement was on the heels of a record 31.4% decline in the second quarter, but still was welcomed news.  Other economic numbers gave investors optimism.   Durable goods orders were up 1.9% month over month, nonfarm payrolls added 661,000 jobs in September, the unemployment rate dipped to 7.9% from the previous month’s 8.4%, core Consumer Price Index (CPI) was a tame 1.7%, Producer Price Index (PPI) was 1.2% on a year-over-year basis, retail sales grew 5.4% year-over-year, and the housing market remained strong. ³

The stock market hit a speed bump in mid-October as investors reacted to a global resurgence of the virus, fear of more economic shutdowns, realization that any U.S. fiscal stimulus would be a post-election event, and anxiety over the election itself.  The S&P 500 entered October at a level of 3,380.  It peaked at 3,540 on October 12 and then gave those gains back and more, finishing the month at 3,270.  Other major stocks indices also finished October in the red.   The NASDAQ Composite lost 2.3% in October while the Dow Jones Industrial Average and the S&P 500 also posted negative returns of 4.5% and 2.7% in the month.  International stocks had mixed results with international developed stock markets falling 4.0% and emerging markets were the one bright spot climbing 2.1% in October. ⁴

With the Federal Reserve on permanent hold and inflation under control, the U.S. Treasury yield curve was stable once again.  During October, the 2-year U.S. Treasury note rose 1 basis point to yield 0.14% at month end.  Longer maturities saw the yield on the 10-year note and the 30-year U.S. Treasury bond move higher.  Interest rates on the 10-year and 30-year each rose 19 basis points bringing their month end yield to 0.88% and 1.65% respectively.  Concerns of mounting federal deficits and future inflation are continuing to steepen the yield curve.  Mortgage rates remain low however, helping to sustain the strong housing market.  Credit spreads in both high yield and investment grade corporate debt narrowed marginally during October. ⁵

As we look to the future it is important to have both a short-term and a long-term outlook for the economy, the stock market and the bond market.  Over the next three months the likelihood for a post-election fiscal stimulus plan is high, and if enacted this should be favorable tailwind for the markets. Regardless of the election outcome, the short-term looks positive. One caveat is a contested election which could derail any post-election relief rally and stall any stimulus program into next year.

A longer-term outlook will come into better focus after the results of the 2020 elections are known.  The market is familiar with Trump’s policies and will likely respond favorably to four more years of business-friendly decisions from Washington.  If the Democrats take control of Washington, the markets will need to adjust to a new sheriff in town.  Higher taxes and more regulations will likely take a longer-term toll on the markets.

Still looming is the pandemic and the impact it will have on the economy.  Obviously, a successful vaccine sooner rather than later could give the markets a huge boost heading into 2021.  Regardless of your political leanings or COVID-19 beliefs, your portfolio should be well balanced heading into the election and year end.  Take the breaking news of the day in stride, control your emotions as best you can and keep your portfolios well-diversified at a risk level designed for your personal financial situation.

MARKETS BY THE NUMBERS:

Sources:

^{1 https://us.dimensional.com} 

^{2 www.morningstar.com}

^{3 www.bloomberg.com/markets}

^{4 www.morningstar.com}

^{5 www.treasury.gov/resource-center/data-chart-center}

The third quarter of 2020 supported both the bullish and the bearish case for the markets and left investors unclear as to where the fourth quarter might head.  The bulls were firmly in control in July and August as U.S. stock markets achieved multiple record highs after the best August performance in over three decades.  The strong rally from the March lows seemed unstoppable as most indices moved into positive territory for the year.  Bulls were energized by:

• Stronger than expected employment results
• Strength from big technology in the post COVID-19 economy
• Monetary support from central banks and the hope of additional fiscal stimulus
• Better than expected corporate earnings with above consensus forward guidance
• Prospects for an effective vaccine

The bears gained control in September.  A 10% market correction from the August highs came quickly.  The high flying technology sector with their lofty valuations fell back to the pack while forgotten value plays like Deere, Caterpillar, and Coca-Cola showed signs of life.  The bears’ point of view is supported by:

• Fiscal and monetary support for the economy has likely peaked
• Unemployment numbers will remain elevated as small business struggles continue
• Third quarter earnings season must deliver on expanded expectations
• Stock valuations are over extended
• Mounting fiscal deficits are a legitimate concern

Volatility spiked in September, but from a total return standpoint most assets posted positive results in the quarter.   A diversified portfolio invested in the S&P 500, international stocks, U.S. bonds, and gold individually returned 8.9%, 4.8%, 0.6%, and 13.3% in the third quarter.  These same assets over the trailing twelve months produced returns of 15.2%, 0.5%, 7.0%, and 28.1%.  Considering the effects of the pandemic and the impact it had on the economy, these are outstanding outcomes.  The patient investor has been rewarded for staying calm during the storm.

While stocks have provided investors with a thrill ride, the bond market has proven to be a safe haven.  The U.S. Treasury yield curve was basically unchanged throughout the third quarter.  The yield on the 2-year U.S. Treasury note fell 3 basis points to yield 0.13% at quarter end.  At the longer end of the yield curve, the 10-year note and the 30-year U.S. Treasury bond rose 3 and 5 basis points respectively to yield 0.69% and 1.46% at quarter end.  Credit spreads in both high yield and investment grade corporate debt narrowed meaningfully during the quarter.  Stable interest rates and tighter credit spreads kept mortgage rates low keeping the housing market strong.  The Fed will be on hold for the foreseeable future, so expect interest rates to remain subdued. 

This year can best be described as unpredictable.  The pandemic has changed the economy, business, work, school, and our lives in ways we never envisioned just nine months ago.  Looking ahead to the fourth quarter, it appears to be equally unpredictable.  Questions surrounding COVID-19, a vaccine, the election, the path of corporate earnings, additional fiscal stimulus, and economic growth will likely become clearer by year end.   

The financial markets are starting the fourth quarter on a relative high note providing investors a golden opportunity to reevaluate their portfolios and risk exposures.   It’s imperative to take a long-term balanced approach to your portfolio and it’s just as important to set your risk tolerance to comfortably weather future volatility.  Markets are moving at speeds we never thought possible and it is necessary to properly position your financial plan to stay invested for the long haul.

MARKETS BY THE NUMBERS:

The summer of 2020 is coming to a close, the pandemic lives on, and the election is now in the spotlight with both political conventions completed in unconventional fashion.  Major U.S. stock markets achieved multiple new all-time highs in August and now show positive returns for the year.  Investors appear to be looking right through the current wall of worry and focusing on where the economy can go versus the current state of the economy.  The markets seem to be brushing off the election, further impact from Covid-19, and national debt levels which have gone through the roof.  Despite all the concerns and distractions, the stock markets appear to defy gravity on a daily basis.

The economic numbers released in August cannot fully explain the strength exhibited in the monthly stock market returns.  The August unemployment report showed 1.8 million jobs added, in line with expectations.  The unemployment rate fell to 10.2%, down from the previous month’s 11.1% rate. In September, the unemployment rate is expected to return to single digits, but it is still a long way from the 3.5% rate just prior to the pandemic.  Inflation ticked higher for the month with the Consumer Price Index and the Producer Price Index each rising 0.6% on a month over month basis.  Retail sales and durable goods recorded increases of 3.6% and 11.2% respectively. 

The housing market has been the shining star in this cycle.  The work from home dynamic along with social unrest in major cities and low mortgage rates has created an enormous demand for single family homes.  The housing numbers in August were astounding:

• Housing starts were up 22.6%
• Existing home sales rose 24.7%
• 5 million building permits were issued
• Pending home sales increased 5.9% last month.

The pandemic has changed our lifestyles and behaviors in ways no one could have predicted just six months ago.

The stock market continues to move onward and upward logging the best August returns since 1984. Expectations for second quarter corporate earnings were low, but companies across the board reported better than expected results.  In the retail space; Target, Walmart and Best Buy reported excellent numbers sending their stocks to 52-week highs.  Federal Express and UPS were beneficiaries of the huge  e-commerce wave. Big technology names like Apple, Amazon and Facebook continue to lead the NASDAQ Composite to new heights now trading at levels nearing 12,000.  The S&P 500 is also trading at all-time highs with the five largest companies in the index (Apple, Microsoft, Amazon, Facebook and Alphabet) now representing over 20% of the index.  The NASDAQ Composite returned 9.7% in August followed by the Dow Jones Industrial Average up 7.9% and the S&P 500 posted gains of 7.2% in the month.  International stocks also had a profitable month with international developed stock markets rising 5.1% and emerging markets adding 2.2% in August. 

The U.S. Treasury yield curve steepened in August as the short end of the curve is in a Federal Reserve induced lock down. This may not be the start of another seven-year zero interest policy by the Fed, but it could easily last for the next four years.  The long-end of the yield curve is beginning to feel the pressure from mounting federal deficits.  In August, the 2-year U.S. Treasury note rose 3 basis points to yield 0.14% at month end.  At the longer end of the yield curve, 10-year note and the 30-year U.S. Treasury bond made a significant move to higher interest rates.  Interest rates on the 10-year and 30-year rose 17 and 29 basis points respectively bringing their month end yield to 0.72% and 1.49%.  Mortgage rates remain low helping to sustain the strong housing market.  Credit spreads in both high yield and investment grade corporate debt narrowed marginally during the month. 

Markets will likely be volatile as we head into the unknown of the November elections.  The economic policies emanating from the two parties are vastly different and will impact both the economy and the markets well beyond 2020.  The path of the pandemic will also influence business.  Large corporations, like those in the S&P 500, are successfully managing their way through the pandemic while small businesses are taking the brunt of the storm. Collectively, small business employs a large percent of the country and as more small businesses permanently close, the employment rate will be negatively affected. 

The past eight months is a perfect example of the market’s ability to whipsaw unsuspecting investors.  Investors need to take a long-term balanced approach to their portfolio and overall financial plan.  Markets move at speeds we never thought possible and it is imperative to position your investment portfolio at a risk level consistent with your investment goal and objectives.  Set your course and stay your course for the long haul. 

MARKETS BY THE NUMBERS:

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222