Given the combination of (1) significantly diminished global growth due to the recession from the COVID-19 pandemic, (2) a strong U.S. and global central bank monetary policy response in combination with fiscal policy stimulus, and (3) stable inflation, our portfolio positioning favors a conservative asset allocation approach to global equities and fixed income with the following expectations:
- Long-term expected returns for all asset classes may be below returns experienced over the last ten years; however, returns for equities should be above those for fixed income for some time with higher volatility compared to the previous 18 months.
- Several exogenous threats (COVID-19 pandemic fallout, Federal Reserve Bank monetary policy mistake anxiety, tariff conflicts, and political intrigue) may continue to unsettle capital markets at any time.
- Despite the recent sell-off and subsequent recovery, global equity valuations are above long-term averages and long-term growth expectations.
- Real asset equity alternatives should offer lower correlation, inflation protection, and differentiated returns compared to Fixed Income.
- Fixed income remains prudent for downside protection.
- Assuming your plan, risk tolerance, and investment policy are aligned, caution is warranted tactically, but in our view, long-term investors need not take drastic action.
“Change is the only constant in life.” - Heraclitus of Ephesus
“No man ever steps in the same river twice, for it’s not the same river and he’s not the same man.” - Heraclitus of Ephesus
It is rare we can use two top quality quotes from one person. Still, Heraclitus’ wordsmithing is par excellence (no surprise, he was someone who had a significant influence on Plato and, as a result, Western philosophy!)! Both of these quotes seem appropriate today, given the capital market ride over the last six months.
The world has seemingly changed very much.
We don’t recall many six-month periods after which the world felt as changed as it does today. Maybe 9/11. Maybe 2008-2009. Today it feels like a combination of both of those periods. We have the magnitude of the societal change from the fallout of the covid-19 pandemic, similar to 9/11. And we have the financial effects reminiscent of capital markets between 2008-2009, only this time, both the equity market and the economy drawdowns and subsequent recoveries came over a very short period.
But, as Heraclitus reminds us, change happens all the time, and our present is no different. At the same time, today’s capital market and economic theatrics may look like the same rivers as before, but they are clearly not. As a corollary, it would be a mistake to expect a speedy return to pre-pandemic normalcy, and, similarly, a mistake to suggest the pandemic changes everything going forward.
Our investment strategy is focused on long-term investment returns and expects capital market and economic dislocations from time to time. We also assume the pandemic will end, the quarantines and social distancing requirements will end, normal life will gradually resume, and the economy will recover.
So far, so good.
The Federal Reserve Bank’s monetary policy and the government’s fiscal policy responses were unusually quick, robust, and well-aimed. Everything from the Fed’s open market purchases of securities as the buyer of last resort to the government’s Payroll Protection Plan put cash where it needed to go and instilled confidence in the financial system. The combination has helped mitigate a financial panic and the subsequent economic fallout from the COVID-19 pandemic.
As a result, the economic recovery looks promising. While few market observers predicted a “V-like” recovery, we see precisely that in recent economic data:
INITIAL JOBLESS CLAIMS – The chart below is the 4-week moving average of those folks who have filed for unemployment benefits for the first time every week. As a leading indicator for broader employment trends, this “inverted-V” pattern bodes well for the economy.
RETAIL SALES – The chart below shows a “V-shaped” recovery in monthly aggregate national retail sales. After falling off a cliff in February, the robust recovery shows consumer spending has returned for now.
NEW CAPITAL EXPENDITURE EQUIPMENT ORDERS – The chart below shows a “V-shaped” recovery in monthly survey data of the spending intentions on significant capital outlays of business decision-makers across industries and company sizes.
SMALL BUSINESS OPTIMISM – The chart below shows a “V-shaped” recovery in monthly survey data of small business owners’ optimism about the future, which is a reliable forward indicator of economic growth.
Of course, we don’t know if these recent positive trends will continue.
It would seem soaring coronavirus case counts in the Sunbelt states (Texas, Florida, and California represent 30% of U.S. economic activity), and current efforts to reverse some of the re-openings in these states would exert a headwind to the robust economic recovery that began in May. Other high-frequency indicators (for example, 7-day average TSA clearings and Open Table seated diners) suggest that after a V-shaped recovery pattern in May and June, the upswing may start to stall in July. We expect the strong economic recovery to slow down from here but not to reverse.
What would cause us to worry about the current recovery? The single economic indicator we watch most closely is initial jobless claims. If the data begins to shoot meaningfully higher, we will become more concerned.
In the interim, we shall see if more serious efforts at voluntary social distancing and mask-wearing across the country begin to turn the tide on infections in the weeks ahead. It is also important to note that the Spanish flu pandemic back in 1918 did start to die out in July and August of that year. Recent national data suggest the rate of infection is beginning to level off once again. Obviously, if a vaccine becomes available soon (ideally by early next year), it could be a real human health and economic game-changer.
Again, for the reasons mentioned above, the macroeconomic backdrop continues to be tough to figure out today. We will stay focused on our high-quality leading economic indicators to help us understand the macroeconomic environment going forward and its effect on capital markets.
As responsible financial advisors, we have the humility to know we cannot predict the future with precision. With sound financial plans in place, as mentioned above, we believe a more conservative client portfolio asset allocation is prudent given the intermediate-term macroeconomic environment we are facing today.
As always, the future direction of macroeconomics and, more importantly, capital markets in 2020 is still anyone’s guess – we have not even mentioned the upcoming political season, which may spark some volatility soon.
As always, we focus on conducting ourselves as long-term investors delivering investment outcomes that help our clients meet their wealth-planning objectives.