As this year grinds on, even the most optimistic among us have surely had to search hard to find silver linings in this year’s events. As you read this, we now have a president-elect declared by the media and a president in office who is riding out the clock for the elections process to be finalized. I knew prior to the election that half of my clients, my family and the nation were going to be disappointed in the outcome. This race and the prior presidential race were just so close that it is hard to come together and have a group hug when your candidate won or lost by so fractional an amount. My personal feelings aside about my candidate, my professional job is to talk about how the elections may or may not impact the financial markets. The good news is that in the short term (1-2 years), I think the outcome of this election will have little impact on the markets.
My confidence in the statement above is because in a capitalist society, which we still are, the stock market has gone up under every type of president. The stock market has gone up when the same party controlled the House and the presidency, but it has also gone up when government was divided and one party did not control all branches of government. There are some statistical differences, but as one trusted source said, we just do not have enough data points to firmly establish if Blue or Red governments are “better” for the financial markets. This year, we have a great example of what economists call an exogenous event – COVID -19. Exogenous events are things outside the normal course of events that have a sizable impact on what you are trying to measure. Certainly, COVID will have a big impact on President Trump’s final market stats and it could have a detrimental impact on the start of a Biden presidency as measured by financial parameters. The impact of COVID would be a curveball to any president, no matter their health and economic policy approach.
So, after COVID has canceled Memorial Day, the Fourth of July, Labor Day, most of Halloween and is starting to take down Thanksgiving and schooling across the country, what do we have to be thankful for? Well, as of this writing, we have at least two good vaccine candidates for the virus that should be available to us in early 2021 and beyond. Hopefully, summer vacations will return and schools will start the old-fashioned way: in person, in the fall. It looks as if our messy and fractured election process is working and we will continue to have divided government. Once again, we do not have enough data points to say this is best for the financial markets, but one thing we know is that financial markets, like most people, do not like change. Markets want predictable futures with gradual improvements. On that note, divided governments rarely get anything done quickly. But, as seen with the current stalemate over a second fiscal stimulus plan, our divided government has not yet reached an agreement to help offset economic hardships many are feeling in the hospitality, travel and service industries. So, while most of the economy is adapting, not all businesses will survive. In fact, a sizable portion of market gains this year has been concentrated in the very largest companies as they have been viewed as “safer” by investors.
How are this year’s events impacting portfolios?
This year we have seen heightened volatility, first on the downside and then on the upside. We have tried to stay calm, not make any knee-jerk reactions and remain true to the plan. We did not place many trades during the market sell-off or in the early days of the recovery. Just like the analogy of trying to catch a falling knife, if you place trades before you have all the information, you are likely to get cut.
One thing is for sure, 2020 has produced a bifurcated market with clear winners and losers. The winners have been stocks in industries that have not been hindered by COVID restrictions. This includes technology companies that enable us to work from home, companies that allow us to buy goods and have them delivered to the front door and healthcare companies working on anything related to COVID, whether it be biotech companies trying to find a cure or suppliers providing testing equipment. But just as there are winners, there sadly must be losers. Energy companies have been hurt as lack of demand curtailed the use of oil and financials felt the pain as interest rates dropped to historically low levels. Travel, retail, and entertainment have all been hindered by lockdowns and governmental restrictions. This caused a huge gap in performance between growth (led by technology) and value (which includes financials and energy). Standard & Poor’s divides its large-cap benchmark index (S&P 500) by growth and value characteristics. Through the end of October, the S&P 500 Growth Index was up 16.89%, while the S&P 500 Value Index was down -13.24%. This 30% difference is the largest difference on record, even larger than the gap during the dot.com bubble of the late 1990s.
So, a question we often get is “why do I own value stocks?” At Bill Few Associates, we always preach diversification. There are periods when different strategies or portions of the market outperform, but these periods do not last forever. We feel it is important to smooth out returns and always have something that is working. Let’s take a closer look at growth versus value. First, we will look at the growth side of the equation. Owning nothing but technology would have worked great over the past few years, just as it did in the late 1990s. Today, just as then, it seems obvious that technology is the wave of the future and will always outperform. In the late 1990s, we were discovering the amazing capabilities of the internet and cell phones. Leading companies like Cisco, Intel, Microsoft, Dell and AOL were making money and providing technologies we could not live without. But their stocks reached levels that were not supported by their earnings and they lost most of their market value. Technology ended up being the worst performing sector in the decade starting in 2000, despite many more technological advancements. Today the market is led by Facebook, Amazon, Apple, Netflix and Alphabet (Google). Again, these are companies that are making money and providing services we cannot imagine living without. But the question is, do their earnings justify the explosive market returns they have generated? We are not sure how the story will end, but markets tend to adjust when we reach extremes.
When examining the value side of the equation, we see a lot of unloved industries and companies. Some of them are producing solid profits, like most consumer staples and utilities companies. However, many are in industries impaired by COVID restrictions, such as the transportation industry. What would allow these industries and their stocks to thrive? Typically, the economy and stock markets work in cycles. The economy has a recession, it booms off the bottom and then finds a sustainable level of growth until the next recession. The market usually declines leading into the recession, is led by cyclical value stocks anticipating fast growth at the beginning of an expansion before growth names take over when the economy is in a modest growth mode. The cycle then repeats. In 2007-08, we experienced a severe recession and the market reacted accordingly with a severe bear market. In the initial recovery phase, financials and other value stocks outperformed, as expected. But the economy never experienced the explosive growth one usually sees at the beginning of an expansion. Instead, we had slow economic growth that lasted for a decade. It was the longest expansion on record, yet, it had the lowest growth rate. This was the perfect environment for growth stocks to thrive, and they did. Fast forward to today. We experienced a terrible recession when our economy was shut down in the spring. The markets went down but then rallied, anticipating a fast economic recovery. At first, only growth stocks went up. But as shutdowns were lifted, value stocks started to outperform. Unfortunately, with inconsistent news related to COVID cases increasing and shutdowns lifted, value’s outperformance has been a series of head fakes. A more recent example of this market behavior is the positive news on the vaccine front. Each day the headlines promote positive vaccine news, value stocks outperform. Each day the headlines talk about increased case counts, technology names retake the lead. We believe once the economy has reopened, the market will reassess valuations and the companies you hate to own today will be among the leaders.
What’s Likely to Happen Next?
Unless we discover that pumpkin pie or gravy is a miracle cure for COVID, we can expect virus cases to get worse before we get access to vaccines in 2021. Until then, we have a government in transition and so far, no progress on additional stimulus to help those without jobs due to the virus. Therefore, the financial markets could be volatile too. When investors focus on the long term, the market rallies on a return to normalcy. When investors focus on the short term of increasing virus numbers and pockets of economic disruption, the market tumbles. We remain diversified and willing to be nimble and buy the dips or sell the rallies as needed to keep your account balanced and aligned with your personal investment objectives. This commentary was co-written by myself and Tom Beilstein, my co-chief investment officer. Tom wrote the middle of this update on value vs. growth; I penned the beginning and the summary. You can reach out to us or your consultant if you have any questions or concerns about your investments with Bill Few Associates. Stay safe and enjoy the holidays.
Mike Kauffelt, CFA
Tom Beilstein, CFA
Co-CIOs, Bill Few Associates, Inc.
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