The Power of Optimism

July 13, 2020 –  Rebounding from a pandemic-induced freefall in March, stock indexes have regained most of their losses and are now back near pre-pandemic levels. Stock indexes have posted the best quarterly return in decades. However, there is still a notable gap between the current uphill climb faced by most businesses and the stock market’s present level. The market has improved, with a loss of about 3% year-to-date as of June 30^th. The S&P 500 Index now stands only 8.7% below the February all-time high. On the other hand, the economy and, in turn, the profit potential for companies over the next twelve months, have been hurt, and we don’t yet know the full extent of the impact or when the country will return to normal activity.

The discrepancy between what is happening currently in the economy, and what is happening in the markets is because investors tend to look at least a year ahead and invest based on their views of what the future holds for their companies. That longer-term view has been optimistic since late March, relative to the current economic environment, encouraging investors to bid up stock prices.

This optimism has been fueled by several recent events that indicate economic recovery. First, reopening of businesses and a view that further broad closure mandates will not be necessary. Further, the enormous stimulus responses by Congress’s CARES Act and the Federal Reserve’s increase in liquidity, making many forms of money readily available, have arguably provided the market’s largest boost. Both institutions have additionally promised more aid if needed. Investors have also been emboldened by positive surprises in economic data such as the May and June employment reports showing a record number of jobs returning and rebounding retail and home sales data. Finally, the stream of headlines about promising results for vaccines and treatments for the virus have added to the economic optimism.

Although the headline numbers for the S&P 500 Index and other broad indexes seem extraordinary, investors must differentiate between the performance of the index which is dominated by a handful of very large companies and the remaining 99% of the 500 largest U.S. stocks. The top 1% of companies by size—Apple, Microsoft, Amazon, Alphabet, and Facebook— have an outsized effect and have far outperformed the rest of the index. When we look at the other 495 individual stocks that make up the S&P 500 Index, opportunities abound to invest in solid companies with reasonable valuations, of which many pay a dependable dividend of 2% or more. When compared to intermediate-term corporate or government bonds paying interest of 1.5% or less we currently view these quality companies an attractive place to allocate money.

The second half of the year could continue to be volatile with the ongoing pandemic and upcoming election.  Investors need to be comfortable with their investments and confident enough to maintain their strategies through an unpredictable period ahead.  Where suitable, we intend to be opportunistic buyers of quality stocks through the summer and fall, taking advantage of any volatility. We are currently taking a conservative approach to investing cash by averaging into stocks over many weeks. For the investor with a timeline of many years, shares bought now should make great long-term holdings.

We see the current U.S. stock market as fairly valued. The price of stocks relative to earnings and other estimates of value may have gotten ahead of themselves, especially when companies are withdrawing earning guidance due to lack of visibility. Full valuation is not at all uncommon and alone does not indicate a market decline is near. In fact, we continue to view U.S. stocks as the most attractive major asset class with interest rates near zero and inflation dormant at this point.

International economies generally were not as strong as the U.S. economy going into the virus shutdown and have not recovered a strongly thus far. The Eurozone is ahead of the U.S. in dealing with COVID-19. That paired with a more planned stimulus could set up European stocks for a comeback. We are maintaining foreign allocations primarily in Europe with additional diversification in emerging markets when appropriate.

The outlook for bonds remains mixed: interest rates are at historic lows and, at the same time, the Federal Reserve committed to keeping short-term rates low for many quarters to come. The benchmark 10-Year Treasury bond ended the quarter at a yield of 0.65%, down from 1.92% at the start of the year. Expected returns in bonds are modest, and parts of the corporate bond market involve higher than normal credit risk. We prefer to build core portfolios of individual municipal or high-quality taxable bonds and supplement with small allocations to specialty bond funds.

Commodity indexes, as usual, were influenced primarily by the price of oil which was at historic lows in April. The price has since recovered as demand returned and production has been slowed. Real estate has also rebounded from Spring lows but has yet to retest the February high.

Although we provide an overview of many areas of the market, our focus when managing your portfolio is on your personal goal and an individualized strategy to reach that goal. We welcome your feedback and questions.