By Deron T. McCoy, CFA®, CFP®, CAIA®
Chief Investment Officer
MAKING SENSE OF THE LAST FIVE MONTHS
How have stock prices risen considering the resurgence of COVID-19 cases/deaths and weakening economic data?
I certainly understand the question, but it is important to remember that not ALL stock prices have risen. Some stocks (companies) have been seriously impacted by either the virus itself (which damaged manufacturing supply lines) or the “cure” (with the global lockdown negatively affecting the demand for services). As a result, a great many businesses have had to lay off a record number of employees.
It’s also important to remember, however, that for the very same reasons some companies have benefitted from this new type of economy – with the demand for computers, software, online entertainment, online retail, cashless payments, and essential goods (which for adults with children include surfboards, golf clubs, and a desk for homeschool) is at an all-time high! This is an economy of ‘must-haves,’ with everything else taking a back seat. As a result, the apparent universe of investment choices has dwindled with investors all clamoring for the same type of ‘must-have’ stocks. And as a result, prices and valuations have reached new highs.
- Mission-critical assets > Frivolous assets
- Online shopping > Brick and mortar
- Warehouse real estate > Mall real estate
- Work From Home solutions > Commercial real estate and corporate travel
- At home entertainment > Leisure & travel
- Home improvement > Traditional retail
- Electronic payments & trading > Traditional banking
- High cash (balance sheets) companies > Highly levered companies
MAKING SENSE OF THE NEXT FIVE MONTHS
Will there be another dip?
Yes. Not to be glib, but stocks inevitably selloff from time to time. And it will happen again. It’s important, therefore, to try to check your emotions at the door. Stocks historically sell off 30% every few years—it just happens. If you’re prone to sell on that sort of decline, then you probably shouldn’t own a portfolio that’s subject to those types of selloffs in the first place.
With the uncertainty around the upcoming election and a potential virus surge come winter, should we now underweight stocks?
No. Well, let me clarify that. Cash that’s needed for everyday living expenses should not be invested in stocks. So, if your December rent is invested in Tesla, then yes—you probably should consider selling some stocks here. If, on the other hand, you’re prudently invested and well-diversified, then we believe stocks should be higher come 2023 in a post-COVID world.
Speaking of COVID, what is SEIA doing with COVID-19 related stocks now and what’s going to happen heading into 2021?
No one knows for certain what the next six months will look like, but we have a good idea that they will be better for the economy than the previous six months. That’s a pretty easy statement to make considering we just experienced the worst GDP decline since the Great Depression! As the economy starts to recover and as treatments and a vaccine (or three) materialize, the companies and stocks that have been left behind may start to show some signs of life. Investors will then likely begin rotating away from work-from-home/mission-critical assets to assets that will do better under a reopened economy. As a result, the stocks that outperformed in 2020, may be the assets that underperform in 2021.
Now that Technology and Large Cap Growth have continued to do well, do we take profits? Is tech going to die?
Yes—take profits. No—tech is not going to die. Society just accelerated and brought forward five years of technology-related demand into the last five months. The stock price appreciation we’ve recently seen isn’t likely to continue at the same pace going forward.
MAKING SENSE OF THE FUTURE
If the current pandemic lockdown continues into next year, how will it impact both the U.S. and global economies? Will the U.S. be able to recover?
We believe that there is a high probability of the pandemic continuing into 2021, and possibly persisting somewhat into the latter part of next year. The repercussions are numerous. With lower incoming tax payments and higher outgoing stimulus checks, government debt will continue to soar. Ramifications might include:
- Foreign currencies > U.S. dollar
- Lower future GDP growth (after a pent-up post-vaccine bounce)
- Higher inflation (post-vaccine)
- Lower growth + higher inflation = stagflation 3-5 years out (subject to change as not currently in our investment landscape and investable timeline)
- Growing populism and higher taxes
You mentioned government debt, will it ever be a real drag on the economy?
If society remains reluctant to go outdoors, then it doesn’t really matter what the deficit is. At some point in the future, however, it will (or at least it should) according to history. History books suggest that higher deficits lead to higher interest rates and lower GDP growth. But with new monetary policy tools such as negative interest rate policy (NIRP), zero interest rate policy (ZIRP), QE-infinity, and now modern money theory (MMT) surfacing, we may not be able to rely on history as a guide. It will be important in the years ahead for investors to be dynamic and fluid enough to pivot as the new landscape unfolds.
When interest rates go up, can the government afford anything other than the interest on the debt? What repercussions would this have?
I love a loaded question! Your question on interest rates starts with “When” but in this type of economy, the question might need to start with “If,” as interest rates look to remain low for quite some time—although it appears that we may have seen a low in medium-term interest rates for this cycle, with the yield on the 10-Year Treasury bond bottoming around 50 bps. Perhaps the yield moves north towards 1.50%, but that might be it, though, as we are not likely going back to the era of 4% money markets anytime soon. Short-term rates should be pegged near zero for a considerable time—in part to stimulate the economy, but also to enable the government to borrow cheaply. And Jerome Powell’s comment in late August further supports our view.
The bad news is that there are negative longer-term ramifications to this policy. As we the U.S. saw 50 years ago, an artificially low interest rate environment leads to excess and ultimately blooms into full-fledged inflation as it did with the runup into the 1970s inflation scenario.
Other than devaluing the dollar (as the Germans did to the Mark after WWI), how can the government address our debt? How would a devaluation impact our savings?
All else being equal, a depreciating U.S. Dollar generally leads to higher inflation which in turn lowers the debt repayment burden years out, as you get to repay current borrowings with future inflated dollars. This is in line with our potential stagflation view above.
What other methods of addressing the debt are there? How will these impact our savings? For a portfolio, what investment instruments do we have to deal with this catastrophic situation?
The silver lining in all this potential doom and gloom is that the U.S. economy is dynamic, and the underlying companies can quickly adapt and pivot. Also, U.S. investors are not limited by a bureaucratic, top-down rigid approach, since they themselves can pivot and seek out these new opportunities that should arise (just as they have after every crisis). Furthermore, U.S. investors are not solely limited to U.S. investments—today’s investors can quickly and inexpensively seek out ‘better’ economies and investments outside our shores that might also be denominated in an appreciating currency.
Are there any positives for the U.S.?
Absolutely! While corporate revenues may not surpass their earlier peak in the near future, profits could rebound more rapidly for many companies as costs have also experienced a material decline (e.g., lower rents, lower wages, and lower debt servicing costs due to lower interest rates).
Furthermore, the U.S. continues to lead in imagination. The nascent ideas and trends of today will ultimately lead to huge investment opportunities in a variety of fields including, but not limited to, new technology (autonomous driving, artificial intelligence, 5G, machine learning) but also areas outside of technology including healthcare (gene therapy, molecular diagnostics), consumer discretionary (space exploration, e-commerce, streaming/virtual entertainment), finance (blockchain), industrials (3D printing) and many other areas that are currently being conjured up in a garage somewhere.
Finally, with war imminent between Israel and Iran, how will this impact the markets short-term given everything else that is going on?
Do you know something we don’t? We will try to stay in our lane here and leave geopolitics to the experts, but do keep in mind that U.S. investors have had to worry about these types of issues for the better part of 40 years. There will always be regional global conflicts or some similar issues that investors could potentially worry about. Whether its war, pandemics, or artificial intelligence taking jobs away from our children there will always be challenges—but in these challenges also arise new investment opportunities.
The information contained herein is for informational purposes only and should not be considered investment advice or a recommendation to buy, hold, or sell any types of securities. The information contained herein was carefully compiled from sources SEIA believes to be reliable, but we cannot warrant or guarantee the accuracy or completeness of the information provided. SEIA is not responsible for the consequences of any decisions or actions taken as a result of the information provided herein. With respect to the description of any investment strategies, simulations, or investment recommendations, we cannot provide any assurances that they will perform as expected and as described in our materials. Past performance is not indicative of future results. Every investment program has the potential for loss as well as gain. There is a risk of loss from an investment in securities, including the risk of loss of principal. Financial markets are volatile and there are risks in all types of investment vehicles, including with “lower-risk” strategies. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Investments in overseas markets pose unique risks, including currency fluctuation and political risks, and the portfolio is expected to be more volatile than that of a U.S. only portfolio. These risks are generally intensified for investments in foreign emerging markets. Small cap equities, international equities, and real estate securities are generally more volatile than large cap equities and bonds.
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