A Quarter in Review: Third Quarter 2020

Markets Update: A Quarter in Review

The global capital markets have shown surprising resilience in the face of a global pandemic, rising political tensions – both domestic and foreign, and ended the 3rd quarter of 2020 in much the same place where they started the year. While this may be surprising to many, we remind ourselves the markets do not only consider the current news but look forward – oftentimes by many years – to a post-COVID19 world. Will workers go back to the office five days a week? We don’t think so. Will consumers go back to dining out more frequently? Absolutely, but when will that be? In other words, the winners and losers of the Pandemic economy are driving the current market rise, but who emerges as the eventual winners is not yet clear. This hardens our conviction that maintaining global diversification and rebalancing remains very important in your portfolios.

BONDS 

Investment grade fixed income had another positive quarter on the back of a good 1st half of the year, with U.S. bonds returning 0.62% and global bonds earning 0.68%. Whether government, corporate, or municipal bonds, we continue to favor owning bonds with high credit quality ratings that are less likely to face default as a result of the hardships imposed by the Coronavirus economy. We also maintain a meaningful portion of fixed income portfolios in highly liquid, shorter duration bonds, as a way of providing stability in the portfolio and as a source of liquidity for unexpected expenses.

STOCKS

After staging a spectacular climb in the second quarter, global equity markets experienced another positive quarter that would be considered impressive in any other year. Experts put this rise in equity markets this year in two camps: 1) investors are looking past 2020 to future company earnings once testing and therapeutics are more widespread, 2) the rapid acceleration of a new economy where companies that benefit from ‘working from home’ and online retail are rising in value. All stock indices were positive for the quarter with U.S. stocks up 9%, international stocks up 5%, and emerging markets stocks up almost 10%. All together we see volatility continuing throughout 2020, but volatility is not unexpected in investing, which is why we do not rely on short term forecasts to drive your investment strategy.

ECONOMY

While 3rd quarter economic numbers are not out yet, consensus is virtually unanimous that the 3rd quarter will be classified as the beginning of the recovery. While the recovery is not “V” shaped as some would hope or claim, there is clear improvement from the lows in March and April. The continued recovery of the U.S. and global economies will hinge on each government’s willingness to support those businesses and workers most impacted through large fiscal programs. A new on-again, off-again stimulus package in the U.S. will dictate the speed at which our own economy recovers and there is no doubt it is past due as industries may be forced to lay off their previously furloughed workers. Once the pandemic is brought under control, we expect demand to come back meaningfully. This suggests two things: 1) Resilience from a diversified portfolio across stocks, bonds, and geographies remains important today. 2) Focusing on your long-term investment plan and rebalancing your portfolio will likely be rewarded over the next few years.

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Topic of the Quarter: Is the Stock Market Divorced From Reality?

For many of us, the daily routine has changed dramatically from a year ago and the near future offers little reason to expect any change. 

With this shifting landscape in mind, it shouldn’t be surprising that some companies have prospered during this upheaval while others—especially travel-related firms—have struggled. From its record high on February 19, 2020 the S&P 500 Index fell 33.79% in less than 5 weeks as the news headlines grew more and more disturbing. But the recovery was swift as well: from its low on March 23, the S&P 500 Index jumped 17.57% in just 3 trading sessions, one of the fastest snapbacks ever among 18 severe bear markets since 1896. As of August 18, 2020 the S&P 500 Index had recovered all of its losses and notched a new record high.

Many individuals are puzzled by this turn of events. For those under the age of 75, the news headlines are likely the grimmest in memory: Millions have found themselves suddenly unemployed, and storied firms such as Brooks Brothers, Neiman Marcus, and JC Penney have entered bankruptcy proceedings.

How can stock prices flirt with new highs while the news is so discouraging? One financial columnist recently observed that the stock market “looks increasingly divorced from economic reality.” 

Is it? Let’s dig a little deeper.

The stock market is a mechanism for aggregating opinions from millions of global investors and reflecting them in prices they are willing to accept when buying or selling fractional ownership of a company. Share prices represent a claim on earnings and dividends off into perpetuity—current prices incorporate not only an assessment of recent events but also those in the distant future. In some sense, the stock market has always been “divorced from reality” since its job is not to report today’s temperature but what investors think it will be next year and the year after that and the year after that and so on.

Moreover, the universe of stocks does not march in lockstep. At any point in time, some firms are prospering while others are floundering. This year’s wrenching economic turmoil has inflicted great hardship on some firms while opening up new opportunities for others. Based on this admittedly abbreviated list, it appears the stock market is doing just what we would expect—reflecting new information in stock prices.

No one could have predicted the tumult we have seen this year in financial markets. But investors would do well to focus on what hasn’t changed: 

1. Markets are forward-looking, so focusing on today’s economic data is akin to looking at the rearview mirror rather than the road ahead. 

2. Broad diversification makes it more likely that investors capture market returns that are there for the taking—including companies that do far better than expected. 

3. Since news is unpredictable, a strategy designed to weather both expected and unexpected events will likely prove less stressful and easier to stick with. Bottom line: read the newspaper to be an informed citizen, not for advice on how to navigate the financial markets

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