Top Weekly Themes
- Equities Continue to Climb the Wall of Worry – Since the beginning of the third quarter 2020, the S&P 500 Index has risen over 7%, not including dividends, and is nearly at an all-time high despite rising COVID-19 cases across many states and an increased probability of a Democratic sweep during the November election. Irrespective of one’s political views, an across the board Democratic victory increases the chances of higher taxes and more regulations, which could impede corporate profits – a scenario not typically welcomed by investors. The question we are asking – “is an equity market correction overdue?” as we enter the seasonally weak period from early August through the end of September. Measures of investor sentiment can help gauge whether investors are overly optimistic, which can be a contrarian signal that raises the chances of at least a market pause, or potential pullback. There are signs that investors are getting complacent given the CBOE Total Put/Call ratio has reached its lowest level this year. In addition, Investors Intelligence Bull/Bear Spread, which measures the difference between professional money managers who are optimistic and pessimistic about the near-term outlook for the equity market, is starting to approach an elevated level. However, the AAII Investor Sentiment Survey signifies that individual market participants are still quite bearish. Market technicals are somewhat of a mixed bag, but equities routinely test their 200-Day Moving Average price levels, regardless of the whether the trend is up or down. If that occurred today a 7%-10% correction would not be out of the question.
- Economic Data Continues to Improve but all is Not Well – Several economic reports released this past week beat consensus estimates. Although Initial Jobless Claims are still quite elevated, nearly 250,000 fewer individuals filed for unemployment insurance than economists had anticipated. PMI (forward looking business survey data) released by the Institute of Supply Management (ISM) showed considerable monthly improvements for both the manufacturing and non-manufacturing sectors. One thing to note is that PMI data released by IHS Markit, a competitor of ISM, showed more moderate economic improvements, possibly due to a larger number of small business survey participation. In addition, sources that track more real-time economic data reveal that the U.S. recovery has stalled over recent weeks. Google Mobility, which tracks broad measures of consumer activity, indicated that trips to retail locations, grocery stores and the workplace having flat-lined or decreased in most states affected by the second wave of infections. Opportunity Insights Economic Tracker, created by Harvard and Brown universities in May 2020, showed that spending for both high- and low-income households rapidly accelerated after consumer confidence reached a nadir in early April, but has failed to improve more recently. Our takeaway is that continued economic momentum will likely require a new stimulus bill and avoidance of a material fallout resulting from a second wave of COVID-19 infections.
- Earnings and Market Valuation Update – Based on data released by FactSet as of July 31, 2020, 63% of companies reported earnings for the third quarter. At that time, 84% of companies beat earnings consensus estimates, while 69% surpassed revenue growth expectations. Assuming these figures hold true for the rest of the quarter, the percentage of companies delivering a positive earnings surprise would be greater compared to any quarter going back to 2008, which is when FactSet started tracking earnings data.1 Tech stocks have clearly been the leader in the aftermath of the COVID-19 outbreak, which is demonstrated this quarter with 94% of companies in the sector beating earnings estimates. We do wonder how much demand for various technology solutions has been pulled forward given the increased IT spending to facilitate remote communication, and if longer-term growth rates are sustainable. Even with the improvement of forward 12-month consensus estimates for the S&P 500 Index, which have risen from $141 to $149, the market’s forward P/E multiple is north of 22x. There are numerous factors, including, but not limited to, profit cycles, interest rate levels, supply/demand dynamics (IPO issuance vs stock buybacks), and inflation expectations that can impact the P/E level for equities. A case could be made that a P/E level north of 20x is justified given that interest rates are not far from 0 across the yield curve and inflation expectations are quite muted. However, if history is any guide, P/E levels north of 20x have not been sustainable over the long run.
|Week (%)||YTD (%)||1-Year (%)||3-Year (%)||5-Year (%)||Div Yield (%)|
|Russell 1000 Value||1.3||(11.5)||(1.1)||10.0||32.9||2.62|
|Russell 1000 Growth||4.8||22.0||38.6||81.6||127.2||0.80|
|MSCI EM (Emerging Markets)||2.3||1.0||16.9||12.7||43.4||2.56*|
|Bloomberg Barclays US Aggregate||0.2||7.9||8.9||18.1||24.8||1.03|
|Bloomberg Barclays US High Yield – Corporate||0.7||1.2||5.6||14.8||34.4||5.27|
|Bloomberg Barclays Municipal Bond||0.5||4.2||5.0||14.5||23.0||1.14|
|Bloomberg Barclays Global Aggregate x US (Country)||0.4||5.5||5.5||11.1||23.2||0.69|
|Crude Oil WTI (NYM $/bbl) Continuous||5.1||(31.3)||(21.8)||(15.4)||(6.1)||42.0|
|Natural Gas (NYM $/mmbtu) Continuous||18.4||(1.1)||2.6||(22.0)||(23.0)||2.2|
|Gold NYMEX Near Term ($/ozt)||5.6||35.0||39.3||63.0||88.2||2,051.5|
|Copper Cash Official LME ($/mt)||0.3||4.8||13.9||2.0||24.9||6,453.5|
|1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.18||1.12||1.12||1.18||1.09||1.18|
|Japanese Yen per U.S. Dollar||105.03||108.68||106.39||110.89||124.72||105.53|
|U.S. Dollar per British Pounds||1.30||1.32||1.22||1.30||1.55||1.31|
As of August 6, 2020 (close) *Dividend Yield For MSCI EAFE and MSCI EM are from 6/30/2020.
Chart of the Week
US Dollar Weakens Post COVID-19
US Dollar as Measured by DXY: Ten-Years Ending 8/6/20
- The U.S. dollar has fallen roughly 10% from its high when investor anxiety over the coronavirus pandemic reached a climax in March of this year. Since that time, as the global economy has gradually improved, the currency has continued to weaken.
- The dollar has weakened given the following factors: 1) Thus far the United States has been less successful in curbing the spread of COVID-19 relative to many other countries, which raises some uncertainty about the U.S. economy going forward. 2) The U.S. Congressional Budget Office estimates that the federal budget deficit in 2020 will be $3.7 trillion, which may turn out to be a conservative estimate. 3) The U.S. dollar is a safe-haven currency, and often strengthens as investor fears intensify. As economic conditions improve, and investors take more risk, dollar-based outflows tend to spike. 4) The Federal Reserve has effectively, placed a ceiling on interest rates, and the relative interest rate differential compared to other countries has fallen quite dramatically relative to just two years ago.
- We think that on short-term basis the U.S. dollar looks oversold, which makes a near-term bounce quite possible. However, we think that the U.S. dollar will likely continue to be weak, especially if a second wave of COVID-19 slows the U.S. recovery. A weaker dollar is particularly beneficial to emerging market stocks, as we saw from 2001-2007, as well as 2017. Commodity prices usually rise when the dollar drops. This should benefit commodity exporters and cyclical stocks (Industrials, Energy, Materials), which have larger representation in value style equity benchmarks. EM debt dynamics also tend to improve when the dollar weakens. EM external debt has grown in recent years, especially EM debt denominated in U.S. dollars. A falling dollar reduces the local-currency value of U.S. dollar-denominated liabilities, thus strengthening the balance sheets of many EM companies and governments.
Why Doesn’t BMT Have a Strategic Allocation to Gold?
NY Spot Gold Prices: 1/1/76-8/6/20
Like several equity market sectors, gold has made all-time highs, surpassing the $2,000/oz. price level (see chart above). In fact, the shiny yellow metal has appreciated more than 50% since May of 2019. Negative real interest rates and record fiscal spending, along with other factors, have resulted in record inflows into gold-based ETF products. We have gotten several questions from investors as to why we don’t have a dedicated allocation to precious metals in our investment strategies. At times, gold has effectively served as a hedge against inflation and often outperforms stocks during “flight to quality” periods such as the steep market sell-off in the 1Q 2020 and the 2008/2009 bear market. However, here are a couple of reasons why we are not utilizing precious metals as a strategic (i.e., long-term) allocation in our portfolios, although we haven’t completely ruled out the possibility of a tactical allocation at some point.
First, the risk/return profile for gold has not been attractive over the long-term. As you can see from the table below gold has delivered lower returns with greater volatility relative to bonds and stocks. Also, high quality bonds have provided better downside capture during more turbulent equity markets.
Asset Class Risk/Return
Jan. 1, 1978 – July 31, 2020
|S&P 500 TR USD||11.73||1.00||1.00||15.03|
|S&P GSCI Gold TR||5.59||0.03||0.04||18.86|
|BBgBarc US Agg Bond TR USD||7.30||0.20||0.07||5.31|
|WTexas Crude Int Oil BL||2.36||0.13||0.29||35.12|
|IA SBBI US Inflation||3.39||-0.01||0.00||1.27|
We also believe that stocks prove to be perhaps the best hedge against inflation over long horizons. Although stocks are financial instruments, they ultimately represent ownership of real productive capital and the right to receive the profit generated by that capital. Ultimately, equities preserve a portfolio’s purchasing power better than things like gold, TIPS, and broad commodity exposure. For example, a buy and hold strategy of spot commodities lagged the CPI by 0.66% per year from 1959 through 2004.
Lastly, commodities have no inherent investment return. They do not directly generate investment returns – ultimately their value derives from using them, not owning them.