Monthly Market Update- November 16, 2020
“When the facts change, I change my mind”. This is a very famous quote alternatively attributed to both Winston Churchill and noted economist John Maynard Keynes. But no matter who, if indeed either, first so spoke, I am happy to utilize it.
Caution turns to optimism
The forward-going change of mind is our tone on long-term positioning for client investment portfolios, from one more reflective of caution to one more of optimism. This represents what I call a fairly subtle and ‘incremental’ change, not one of a precipitous nature. But since it indeed shifts us from one side of the balancing scale to the other, I felt it worthy of this mid-month Update. The actual change is noted below.
COVID-19 Vaccine coming soon?
The biggest new ‘fact’ in my opinion is the announcement last week from Pfizer and this morning from Moderna of the late-stage trial success of their respective COVID vaccines. Given that there are significant (including criminal) penalties for material mis-statements involving publicly-held companies, I think we can regard these as unmitigated positives. Perhaps other companies (Astrazeneca and J&J may well be able to tout similar in-trial successes with their products soon. Certainly it will take months and months to actually deliver and administer the dosages. And maybe none will have the 90%+ efficacy in the real world as has been demonstrated in closed clinical trials. But I think we can say with confidence that there seems to be light at the end of the COVID tunnel. Every day that goes by is one day closer to a virus eradication and a resumption of truly normal life.
The election impact
Secondly, the election is over. Some might still dispute what that outcome actually is. But there has been an outcome…and that simple clarification has always provided a source of renewed Street optimism, no matter which party will assume (or maintain) control. At some point sooner rather than later, even if not in lame duck, we’ll get a second round of consumer-based stimulus, ranging from $500 billion on the low side to upwards of $1.5 trillion on the high.
Major fiscal infrastructure package on the horizon?
Thirdly, and in my opinion no matter what D.C.’s eventual configuration will prove to be, perhaps Washington might finally provide a major fiscal infrastructure package, possibly worth well over $1 trillion. This will be almost certainly be the result of a long and arduous process, just as we saw for what became the massive tax cut legislation finally enacted in late December 2017.
But unlike those tax cuts which provided only a near-term burst of real economic activity before its longer term impact settled into boosting only the ‘transactional’, i.e. indulgence-based consumption, a truly worthy infrastructure commitment could well have material positive economic impacts long after the bulldozers and cranes have done their thing. This will be even more true if climate change mitigation and the development of a full-blown alternative energy industry (or, more likely, industries) are a prime focal point.
Pre-COVID, the tax cuts gave us maybe an additional 0.50% of annualized GDP, admittedly nothing to sneeze at in what’s now a $20 trillion annual economy. But then the impact settled down to perhaps half that, thereby never getting us remotely close to the 3% Holy Grail of real economic growth (never mind the 4% promised by then-incoming policymakers}. However, a worthy infrastructure endeavor could add a multiple of that growth over a much longer period of time. According to a report from one major Wall Street firm, such an overhaul could drive more than $15 trillion of growth and 15-20 million net new jobs by 2030.
Potential impact of another tax overhaul?
And should this become an operative story, its potential can’t be disproven until it might actually fail...and that will be months and quarters, maybe even a couple years, from now. For something that big, that significant, and just as with those tax cuts, Wall Street is willing to be as patient as necessary, and will indeed steadily increase its optimism, as long as progress is being made. No matter how long, arduous and even tortuous the process, every day will be perceived as one day closer to final success. It took 13+ months from the 2016 election date until final passage. Though not in a straight line, Wall Street ‘melted up’ more than 30% before its first pre-correction top in early 2018. Maybe, just maybe, 2021 into 2022 will bring something analogous.
A quick, but important, aside. I think we all know that GA’s double run-off will determine which party will control the Senate. Should the Democrats go 2-for-2, it will assume control and Wall Street may well begin to bake in an even higher probability (and magnitude) of an infrastructure package. However, either 0/1-for-2 alternative leaves D.C. in a divided state. Since gridlock is generally regarded as good by Wall Street, we could well be in a ‘heads we win and tails we win too’ scenario, although whatever infrastructure package might emerge will likely not be powerful.
Value of market-based signals
I have oft written in 25+ years of these Updates that market-based signals must be respected for their forward-looking guidance. Bank stocks and the yield curve in my opinion told a very significant and positive story earlier this week, not just with the direction of their moves but also the magnitude. Maybe I’m wrong but it looks to me that Wall Street found itself ‘offside’, caught underweight stocks - and therefore underperforming - versus their benchmarks. This was true for both high-octane traders and long-term institutional investors. Among the latter, we were too, though only fractionally. Trading capital has no doubt removed its ‘offside-ness’ but still has plenty of room to get ‘onside’, perhaps way onside, over the next days and weeks. But the far stronger and longer term impact will come from the latter group as/if it shifts its aggregate trillions into higher stock weightings.
Our reallocation, which we initiated a week ago after the Pfizer announcement, has been to take 4% of balanced client portfolios from intermediate-duration bonds and put it equally into small cap and emerging markets stocks, our two notable underweights within a fully diversified equity portfolio. These have a higher correlation to stronger economic activity than do U.S. Large Cap companies, where we had been previously well overweigh and which have now been now made closer to a neutral position.
Buy on weakness or sell into strength?
Now a week later, November is on track to be the 5th best month for stocks in the last 30 years. And clearly we cheer on continued short-term strength. But this allocation change is not being made just for the next few weeks but is designed to benefit client portfolios for many months and quarters, hopefully even years ahead. We will most certainly be going forward with a ‘buy on weakness’ attitude, rather than one of ‘sell into strength’. But should the potential news coming get better, and stock prices further advance, we may even ‘buy on strength’ as well.
Your comments and questions are most welcome.
Published on: 11.16.20