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2020Q3

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The markets remained resilient through the end of September.  Following four straight weeks of losses, all major market indexes are positive year-to-date.  Specifically, the S&P 500 remains at a positive 3.5% through the 3rd quarter.  The following sectors, Technology (26%), Consumer Discretionary (21%), and Consumer Services (7%), have all generated positive YTD returns.  Current unemployment has fallen to just below 8%. The economy has returned approximately half of the payrolls lost at the start of the pandemic.  Certain economic indicators such as consumer spending, manufacturing demand and durable-goods growth point toward an economy that is recovering.

The quarter was not without its challenges.  The Billy Joel song “We Didn’t Start the Fire” rings in our heads.  Government stimulus, Supreme Court nominations, elections, coupled with the COVID calamity continue to create commotion and noise.  One concern is that while some economic indicators are improving, they are experiencing it at a slower pace than we would like to see.  Although stock market indexes are positive, some sectors, Energy (-48%), Financials (-22%), and Real Estate (-8%), have suffered year-to-date.  Disney announced that 28,000 furloughed workers would permanently lose their jobs.  American and United Airlines cut more than 35,000 jobs.  Positive sentiments in the housing sector have waned.  Housing starts slowed to 0.9% below the July 2019 numbers and 0.01% below the August 2019 numbers.  Furthering the concern, lumber prices have slipped into backwardation pricing, where future bundles are being priced at discounts to current prices.  This may foretell weaker demand.  All the economic stimulus and early access to retirement accounts pushed CPI upward.  This data lends itself to the growing concern that inflation will rear its sleepy head.

Continuing coronavirus challenges persist as well.  The coronavirus has claimed more than 200,000 lives in the U.S.  Although the number of reported cases in the U.S. has leveled off, hotspots are reemerging in the Midwest and even in New York City.  The U.K. is planning for a second shutdown.  France recently reported its highest number of daily cases.  Many are still fearing winter flu season is upon us and the dreaded “second wave” will be inevitable.

Interest rates remain at historic lows and the dollar continues to weaken.  As we write this newsletter, the current 30-year mortgage rate is at meager 2.25%!  The debt markets are so starved for yield that investors have been willing to accept a 30-year bond with a paltry yield of 1.3%.  The demand is further illustrated by the +25% total return of the long bond.

We do believe there are pockets of the market that continue to signal opportunity.  We believe value-oriented companies, specifically in the international value sector, look to be positioned for strong positive future returns.  Antithetical to this, growth companies, globally, continue to price at historically high multiples.  It is our belief that returns will be more pronounced in the value sector in the near term.   Our investment portfolios currently reflect these sentiments.  Please feel free to reach out to us to review this unique situation.  Stay safe

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Seeking Income

Are you looking to retire?  Need income?  Investors are often concerned with how much yield or income an investment can generate. Retirees want to invest money and be able to live off of the income that their investments generate.  Often as investors reach retirement age, they want less risk and don’t want to ride the volatility wave of the stock market, particularly with the recent experience and pain of the 2008 recession.  That pain is so memorable that it still plays a role in people’s willingness to take risk.  How does this impact a portfolio?  “Less risk” becomes synonymous with income-generating investments.

Here’s the problem with focusing purely on income-generating investments…Prevailing interest rates will drive the current rates of respective investments.  Note that prevailing rates are quite low today. During yield starved market environments investors become so desperate for yield that they will chase the very thing that they are trying to avoid…risk.  When demand grows for market starved investments, the prices of these investments appreciate, which leads to further price appreciation.  Investors are forced to chase even riskier investments than before.  The result: risky investments with more potential volatility.    

The problem is that retirees are overly concerned with the income or yield opportunity of a portfolio rather than looking at the total return opportunity.  Consider two portfolios.

Portfolio A: Generates 3% income/yield; and a total return of 5%

Portfolio B: Generates 1% income/yield; and a total return of 7%

The income-focused investor will choose Portfolio A due to an annual income that is three times larger than Portfolio B.  Here’s the problem with this choice. Not only did the investor make 2% less on an absolute basis, but the investor made considerably less after taxes. 

Illustration:

Income doesn’t matter.  It is a marketing tool.  We shouldn’t care about yield or income.  We should only care about our bottom line; or what actually hits our pocket book. 

Contributed by Daren Shavell, CFA