What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were up more than 7% in August
- The developed markets of Japan was up more than 8%.
- Europe and the U.K. were up from about 2% to 3%.
- Emerging Markets were up more than 2% and Asia (Ex-Japan) were up almost 4%
- Global fixed income returns were mixed with high yield bonds positive and others slightly negative.
Where Do We Stand?
- The market rally has continued unabated mocking the risks that prevail.
- Valuations remain extremely stretched while the prospect for volatile events looms on the horizon.
- I remain in a position of avoiding overweights to higher risk areas while maintaining an allocation to large, quality equities.
- I continue to rebalance your accounts accordingly and have been selectively waiting to put more cash to work in portfolios.
As equity markets continued their un-relentless march higher, civil unrest, political squabbling and increasing Coronavirus cases littered the United States. Furthermore, some regions of the world faced a second wave of the virus during the month of August. With better testing capabilities today, policymakers abroad have been able to better react to this second wave. They have been able to rely on much more targeted responses as opposed to the national lockdowns we experienced in the first wave. These better capabilities, a better than expected second quarter earnings season and the potential for a viable vaccine helped to lift risk assets in August. There remains to be seen what earnings will look like once the (now expired) stimulus support begins to effect consumer’s wallets in earnest.
Beware the August Data
Here in the U.S., the number of new daily Coronavirus cases has begun to moderate. However, the percentage of positive tests still remains above limits for re-opening in 27 states. This high infection rate has caused much of the daily reported economic data to move sideways. One example of daily reported economic data is in-store credit card transactions. In a true economic recovery one would expect this data to be improving.
A possible second reason for this sideways movement has been the stalled negotiations on another stimulus bill in Congress. If you remember, the additional $600 per week in unemployment benefits provided by the CARES Act expired on July 31st. So for the month of August anyone who lost their jobs is back on normal (and lower) benefits. These unemployed now total somewhere around 25 Million people. As they begin to halt spending the effect will undoubtedly be felt in corporate incomes. The data for August, which will be reported in early September, will be rather foretelling.
Layoffs Continue
Furthermore, the announcements of furloughed workers being let go is rising. Many of these furloughed workers were still eligible for health and life insurance benefits. The loss of these benefits will be an additional drag on consumer sentiment now. These newly fired employees will also search for work in an environment where no work is to be found. This will further dampen the “recovery”. On September 2nd, United Airlines announced it will furlough more than 16,000 employees once federal aid expires on October 1. MGM Resorts began laying off 18,000 previously furloughed employees on August 28. American Airlines said it would cut 19,000 employees in October. Schlumberger said it is cutting about 21,000 jobs on July 24. This is just a small sample of the cutbacks effecting a very high percentage of public companies in America. One must assume the layoffs in the private sector are equal, if not worse.
The Federal Backstop
Despite all of this, the economic data reported in August pointed to moderating growth. This was opposed to the zero or negative growth many were expecting. For the reasons cited above, one can expect this to continue to be a struggle for our economy. Regional manufacturing surveys have begun to falter, a possible sign of weakness to come. Meanwhile, housing remains a bright spot. In an attempt to further dampen the potential weakness to come, the Federal Reserve recently shifted the rules for their inflation targets. This further signals that the central bank will continue to flood liquidity into the system and keep interest rates low for the foreseeable future.
Interestingly enough, the stock market merely shrugged at the news while the bond market actually drove rates higher. It seems the equity market already expected this change while the bond market reacted to the expectation that inflation will eventually come. Regardless, the simplified reason for this move is that the worst part of this recession hasn’t hit yet, and the Federal Reserve knows it.
The Risk of Risk
That brings us to the risk of risk. As the Federal Reserve continues to be the backstop for all things, the risk of a real catastrophe continues to rise. On the surface, low interest rates and tons of liquidity seems to be good thing. It allows companies to survive. Yet the means of their survival has been to incur mountains of new debt. This debt has helped good companies (profitable businesses with the means to repay the debt) and bad companies (poorly managed, unprofitable companies) alike to survive. This debt will be an issue going forward. While they incurred this debt many companies also reduced their future Capital Expenditure plans. That means the overall economy will be slower growth for longer with lower numbers of hirings as this debt is worked off. Simply put, we can’t just grow out of this one.
Around the World
Further abroad the story remains a mixed one. In Europe the number of new COVID cases has been rising but the policy responses there have been much better than here at home. Governments there have implemented targeted travel measures and face mask requirements that have been mostly heeded. The rise in infections has not yet hurt consumer activity there but business confidence has been effected negatively. In the UK activity strengthened through August. However a looming October end to benefits (much like in the U.S.) and stalled Brexit negotiations have kept a damper on markets there. The Emerging Markets and Asia seem to be a bit ahead of the rest of the world with declining cases in most of their countries. The Chinese economy continues to recover.
Participate but Defend
There remains a high degree of uncertainty around the prospect for a fast vaccine, a continued economic recovery or a stable Presidential election cycle. The relatively quick and large policy responses from governments around the world has managed to soften the initial blow from the pandemic. However, much like a car accident, there is usually much more damage that lies below the surface. One can fix just the dents but if your radiator is cracked eventually your car will die.
Policymakers have tried in earnest to support their economies until the pandemic is over. We won’t know until then what lies beneath the surface and it is best to remain a participant in the economy with defensive leanings. Thus, we target balanced portfolios that are well diversified across industries and sectors while keeping enough liquidity on hand. The liquidity helps one’s personal balance sheet should things get worse, while also offering opportunities in the future to invest more when and where appropriate.
If you have any questions or have experienced any changes in your financial situation please do not hesitate to Contact Me.
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