Market Commentary - October 2020

Monthly Update

The Stock Market

In October, for the 2^nd month in a row the S&P 500 sold off mostly driven by the continued pullback in technology stocks, the sector of the market that has been the standout this year. The 2.8% decline follows a drop of 3.9% in September which was preceded by the sharp rally off the March lows that took the S&P 500 index to record highs, exceeding pre Covid levels[1]. With regards to the tech sector specifically, the S&P 500 Information Technology sector was lower by 5.2% vs the NASDAQ itself lower by a more modest 2.3%[2]. Not all was lost though in the month as the Russell 2000 index of small cap stocks rallied by 1.5% but remains down 7.8% in the year thru October[3].

What was very interesting within the month was the selloff in US Treasuries coinciding with the downturn in the big indices. Rather than rally in a flight to safety, they sold off with the 10 yr yield ending the month at .88% vs .69% at the beginning[4]. The 30 yr bond yield closed October at 1.66%, up 20 basis points[5]. What we saw in October were persistent hopes for a large fiscal spending package out of Congress that while never came to fruition, was consistently expected. Implied inflation expectations in the US Treasury Inflation Protected Securities market also rose along with another avalanche of supply used to fund the exploding US budget deficit. Through September, that budget deficit was 16% of US GDP[6].

Reported in the month was the 33.1% GDP rebound in the US economy after falling by 31.4% in Q2 and 5% in Q1[7]. That leaves the US economy 3.5% below its fourth quarter 2019 level[8]. We expect that 2019 economic peak to be exceeded at some point in the latter part of 2021 or early 2022. Thus, more progress is needed. European and Asian economies also rebounded but the former is now dealing with a new rash of selective lockdowns in response to a spike in Covid spread. Asian economies, particularly China, Hong Kong, Taiwan, Singapore and South Korea have done a great job in controlling the virus and limiting its spread. Their economies in turn contracted less and rebounded quicker relative to the rest of the world.

Speaking of Covid, on November 9^th Pfizer and its joint venture partner BioNTech’s reported amazing news on their vaccine candidate which “was found to be more than 90% effective in preventing Covid-10 in participants without evidence of prior SARS-COV-2 infection in the first interim efficacy analysis” according to their press release. This is certainly life changing and tells us that the beginning of the end of Covid’s grip on our lives is here. The parts of the market that have been hit hard by the shutdown’s will now benefit at the expense of many of the work from home stocks that have done so well this year.

The Election

With now President-Elect Biden and the Democrats retaining control of the House (but by a smaller margin), the two runoff Georgia Senate seats are very important as to who will control Congress. The assumption is a Republican will keep at least one of the two seats and thus we will have a divided government which is a set up that markets like. The question then is what kind of fiscal spending do we see and what is the timing of it. The Blue tide that was a big possibility according to the polls prior to the election didn’t happen which means we won’t get massive fiscal spending but we also won’t have higher taxes. If there is a real loser in this election it is the pollsters where many seemed to be so far off again in their predictions.

The Stock Market

I believe October 15^th was an important day for technology stocks in terms of the market’s possible rethink of valuations. Technology fundamentals in many areas have been stellar, especially during Covid, and the equity prices and valuations have followed. However, we might have reached a point where stock prices have gotten too far ahead of the underlying earnings trends. The reason why I point out that day in October was to highlight the company Fastly that fell 27% that day after reporting earnings that did not meet the very high expectations[9]. Trading at 44 times sales prior to the release left little room for error[10]. At the time I thought that maybe this was a canary singing. For now it was as more tech stocks sold off after reporting earnings in the month, especially the big FAANGM names except Alphabet/Google which rallied.

Again, this is not an indictment of the fundamentals for technology, just a rethink on the prices paid for these stocks. In turn, value stocks have started to trade better and as previously mentioned, the Russell 2000 small cap index along with the S&P Midcap index closed green in the month.

International stocks also closed down in the month but mostly due to weakness in Europe as the continent ended the month in selective shutdowns. The Euro STOXX 600 index was lower by 5.2% in October[11]. In contrast, the Shanghai composite was higher by .2%, the Nikkei fell just .9% and the South Korean Kospi was flat, to name a few Asian markets. As stated, many Asian countries have done a much better job of containing the virus and have since bounced back quicker in response.

The Global Economy

Helping to lift the US economy in Q3 was the gradual reopening and surprisingly good level of consumer spending on durable goods such as autos. Housing has been very strong too as low mortgage rates combined with the desire for more space in the suburbs have been a big help. The challenge now though with housing is that home prices are rising at a quick enough pace that it is offsetting the benefits of lower mortgage rates. Manufacturing has been a source of strength as well as companies’ restock inventories as almost three months of factory shutdowns need to be offset.

Europe’s economy also recovered much of what was lost with a 12.7% q/o/q GDP increase in Q3 after an 11.8% drop in Q2 and decline of 3.7% in Q1[12]. Because the hole there is deep, it might not be until 2022 or 2023 before they regain its 2019 GDP level.

China’s economy was a particular bright spot in Q3 as it actually grew by 4.9% y/o/y[13]. Now we know to take Chinese economic data with some grain of salt, but the trajectory here is what matters. Their economy is fully open and consumers are almost back to behaving like they did pre Covid. In the month South Korea, Hong Kong and Taiwan also reported better than expected Q3 GDP figures[14].

Bonds

While the Federal Reserve kept short term rates pinned at zero and continued with their $120b monthly QE program ($80b of Treasuries and $40b of MBS), long rates rose as stimulus hopes, excessive supply and rising inflation expectations all drove it. I believe that higher inflation is going to be a key theme in 2021, especially now that we have an effective vaccine. We’ve seen a rise in the consumer price inflation stats and a rise in commodity prices excluding crude oil. During October the CRB raw industrials index was higher by 2% and up for the 6^th straight month. The CRB food price index was down by .6% but that follows a 17% increase over the three prior months[15]. Even natural gas rallied as we enter the colder weather, by 7.6%[16]. Crude oil is the only thing that hasn’t rallied but I believe that is to come, especially with a vaccine now upon us.

The US Dollar

The US dollar index was about unchanged in October after rallying by 1.9% in September[17]. It is still down on the year and I believe the sharply rising US debts and deficits are negative in the big picture. That said, it seems like every central bank in the world, except some in Asia, such as Japan, are doing everything they can to weaken their currencies believing that doing so will boost exports and inflation. It is a fiat currency race to the bottom where I continue to believe gold and silver will be the last currencies standing as they are money that can’t be printed ad infinitum.

Conclusion

It certainly has been a crazy, upside down world this year with Covid and nothing like capping it off with an election in a very politically divided country. With now the news of a very effective vaccine, the 2021 Covid news flow will be much better and the election, outside of the Georgia Senate seats is essentially over. That said, the markets will still have to contend with rich valuations both for equities and credit which implies more muted returns going forward.

Regardless of how things play out from here, it is so important that investors have a plan that suits their short term liquidity needs over the coming 24-36 months. Knowing short term liquidity is covered can help cushion the balance of one’s portfolio against what I believe will be a continued choppy time for both the economy and markets. Please do not hesitate to reach out at any time with questions or for any discussion on the economy and markets.

Disclaimer