Q4 2020 CAPITAL MARKET OUTLOOK
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 than the previous 18 months.
- Several exogenous threats (continued 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 than fixed income.
- Fixed income remains prudent for downside protection.
- Assuming your plan, risk tolerance, and investment policy are aligned, caution is warranted tactically, but long-term investors need not take drastic action in our view.
Now more than ever, it seems we get bombarded with tons of information.
As a result, our brains respond by attempting to put things into place to process it all. We develop cause-and-effect narratives about all kinds of things to make sense of the world. Sometimes these narratives are legitimate; other times, we get tripped up with false narratives that make sense on the surface but do not hold up under more in-depth analysis.
From our investment perch, we see narrative fallacies all the time.
As an example, despite being six months into an economic recovery, there is a popular narrative that there is no real recovery since the economy remains depressed relative to its previous peak. Where we come from, a recovery denotes a direction (it can be either up or down), whereas a peaking economy operating at its full potential with full employment represents a destination. The idea that there is no progress (recovery) without the attainment of a destination (back to the peak) is not consistent with the standard business cycle literature we have read.
Another example is the false narrative that there is no real recovery because the equity market is rising faster than the jobs market (an inaccurate measurement of economic inequality). Our interpretation is grounded in a critical investment fundamental: markets always attempt to discount the future. The V-shaped rebound in the equity market from the lows in March simply preceded a largely V-shaped rebound in employment and the broader economy.
Yet another example of a false narrative is that the economic recovery underway cannot possibly continue without more fiscal stimulus. Well, things seem ok to us so far without it! Despite moving well past the July expiration of extended jobless benefits and other fiscal support, we have yet to see evidence of the sudden economic relapse predicted by many financial media pundits.
Our high-powered leading economic indicators have been incredibly steady, registering at or even better than pre-COVID shock levels. These readings would be extremely unlikely if a fiscal cliff and/or COVID itself were to take the economy back down.
What this does suggest is the Federal Reserve Bank's aggressive monetary policy stimulus continues to get traction. As a result, the economy is less vulnerable to a fiscal shock. The still elevated stock of household savings should be sufficient to continue powering the recovery so long as the Fed manages expectations in the right direction.
An economy that continues to move in the right direction bodes well for the corporate earnings recovery and, by sheer force, equities. Anything that upsets economic progress will also, most likely, upset equity returns. As a reminder, our investment strategy is focused on long-term investment returns and expects capital market and economic dislocations from time to time.
For the reasons mentioned above, the macroeconomic backdrop looks good today but continues to be tough to figure out. We will stay focused on our high-quality, leading economic indicators to understand the future's macroeconomic environment 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.
As always, we focus on conducting ourselves as long-term investors delivering investment outcomes that help our clients meet their wealth-planning objectives.