Stocks continued their remarkable rise during the third quarter, fueled by an economic recovery taking shape and continued easing monetary policy from the Federal Reserve. Even though short term interest rates are projected to remain low through 2023 bonds rose slightly for the quarter as some investors trimmed stock positions after the run-up and purchased lower-risk investments. As we predicted last quarter, higher volatility returned to stocks as doubts about the sustainability of the recovery began to creep in by the end of September.
U.S. stocks continued to climb higher as most segments of the U.S. economy reopened. On a relative basis, large-sized companies (S&P 500) outperformed mid-sized (S&P MidCap 400) and small-sized (S&P SmallCap 600) companies. Markets appear to be balancing expectations for 2021 – continued falling unemployment, increasing consumer product demand, accomodative worldwide monetary policy, sustained strength in the housing market – against uncertainty around both the election and a coronavirus vaccine. Although significant risks remain present, stocks appear to be positioned for better relative performance over bonds for the next few years. Overall, U.S. stocks (Russell 3000) were up 9.2% for the quarter.
International stocks outperformed their U.S. counterparts during the quarter. Emerging markets (MSCI EM) again posted better returns than developed markets (MSCI EAFE) on a relative basis, although both had strong absolute performance. Overall, international stocks (MSCI All Country World Index ex-U.S.) gained 6.3% over the three months.
Bonds (Barclays US Aggregate index) rose 0.6% during the quarter. The Federal Reserve continued to signal that short-term interest rates will continue at near-zero levels through 2023. Additionally, the Fed amended their guidelines to allow periods of inflation greater than 2%, especially when following prolonged periods of low inflation. Both of these developments could prove to be headwinds to future bond performance. However, bonds continue to play an important role in a diversified portfolio by reducing overall risk and by serving as a potential ballast against falling stock prices.
Commodities (Bloomberg Commodity) rose sharply during the quarter, even with the price of oil facing an uncertain future due to reduced demand during the pandemic. Global real estate and natural resources (FTSE EPRA/NAREIT Developed, S&P Global Natural Resources) rose to a lesser extent. Overall, alternative assets rose 4.3% for the quarter.
“During an election campaign the air is full of speeches and vice versa.” – Henry Adams
Americans will go to the polls on November 3rd to decide who controls the White House and both houses of Congress. Control of the federal government means controlling the agenda, which in turn will greatly influence issues relevant to investors. Results from a relatively small number of swing states are poised to decide the race. In this hotly contested election cycle, aside from coordinating the coronavirus response, we feel the issues most relevant to investors are:
- Corporate and personal taxes and the effect on the economy and investments
- Government spending and debt
- Our country’s relationship with China regarding national security and trade issues
From April through August, we were conditioned to believe that volatility in stock prices had disappeared. However, recent fluctuations in September are much more normal and we expect that these levels will persist in the future. Regardless of the election outcome, the top priority of federal and local governments must be bringing the coronavirus under control and reopening the economy to a much fuller extent. Until those objectives are accomplished, we believe the choppiness will continue. Over the summer, the market priced in a substantial economic recovery; as we move further along without an approved vaccine or additional government relief, the prospects for achieving those expectations becomes more uncertain.
Although the election outcome also remains uncertain, the key issues (other than the virus) affecting the economy have come into focus. Potential changes to corporate and personal tax policy could certainly affect corporate earnings and consumer income in 2021 and beyond – subsequently affecting asset prices. However, it bears noting that tax policy adjusts often (even without a corresponding turnover in administration), and that these updates may not move markets on their own. Other considerations – the current ultra-low interest rates, unprecedented worldwide monetary stimulus, and the relative attractiveness of all asset classes against each other – should also inform investment decisions.
The issue of government spending and the ballooning national debt will continue to cast a shadow on future economic growth, regardless of the election results. The policy response to the coronavirus (adding over three trillion dollars to the national debt in a matter of months) has only compounded the problem. As more and more debt is issued, investment in Treasuries reduces the capital available for private investments, acting as a drag on productivity and growth. Additionally, interest rates likely will have to rise to entice buyers to purchase larger issuances of Treasuries, which in turn raises the cost of debt service and takes resources away from other priorities that promote growth.
The relationship between the U.S. and China is beginning to resemble the Cold War struggle between the U.S. and the Soviet Union. Direct political and military interactions between the two nations means that the tug-of-war between the U.S. and China will demand the careful attention of any future administration. Although the trade agreement signed in January promised some level of economic détente, the cooperation seems to be tenuous at best. Both President Donald Trump and Vice President Joe Biden have alternated between talking tough about China with more nuanced comments about the importance of the relationship between the two nations. Avoiding a shooting war while still protecting American business interests in the world’s largest market will be a tightrope for whomever wins the presidency.
The pandemic has also affected election norms. While early voting has been a trend for several years, “late” voting could prove pivotal this cycle. Several states are amending their rules regarding accepting mail-in ballots after Election Day – in some instances, up to two weeks after Election Day. This could mean that results for many hotly contested races will not be immediately known once the polls close, increasing the possibility for higher volatility through the end of the year.
We’ve had several clients ask us what to do with their investment portfolio in the midst of all this election uncertainty. While it may be tempting to make financial decisions driven by emotion, making “all-in” or “all-out” decisions – based on an upcoming election or for any other reason – can lead to adverse results.
To be clear, while we strongly recommend that clients continue to follow their financial plan, that does not mean sitting idly by. This is a great time to review with your advisory team both your ability and willingness to accept risk, and to make any necessary adjustments to your financial plan. Remember that your plan is not a static document. Refreshing objectives and making adjustments in the pursuit of optimizing your results is necessary over time. Additionally, this is an excellent time to set aside some cash for larger planned 2021 expenses. Because stocks have significantly recovered from March lows, ensuring that you have proper cash levels now helps to avoid selling in downmarkets later.
Our investment team at Planning Alternatives is busy positioning client portfolios with an eye toward the future. We’ve adjusted our U.S. stock exposure slightly, seeking to benefit from the recovery we see continuing in 2021. We’re interviewing actively managed international stock fund managers, and plan to add one to complement our suite of index investments in the fourth quarter. Additionally, at this time when stock and bond valuations are both elevated, we continue to vet investments with risk and return profiles different from traditional asset classes that have the potential to reduce overall volatility and enhance return.
Whatever the election results, we at Planning Alternatives are committed to helping you reach your financial goals and stand ready with insights and advice to guide you along the way.
Please contact us with questions, or just to chat!