Monthly Markets Memo - September 29, 2020
by Dan Zalipski, CFA
The S&P 500 just had its best August since 1986. Much of the return during the month was driven by continued hopes for a Covid-19 vaccine. The Fed recently reiterated its intentions to keep rates low through 2023 as they believe the pandemic will continue to weigh heavily on economic activity. Negotiations for additional stimulus remain stalled with neither side indicating a willingness to compromise.
Finally, a basket of leading economic indicators revealed that the economic recovery appears to be slowing down. It goes without saying that the pandemic has upended our world in more ways than one. The market is no exception, where some truly unusual circumstances are unfolding.
The first circumstance involves growth vs value stocks. Stocks can generally be classified as growth or value. Growth stocks tend to do just that, grow. These are companies expected to grow at a rate that is significantly above the average growth rate for the broader market. Value stocks are companies that typically trade at a discount relative to the stock’s fundamentals, such as dividends and earnings. These companies tend to be well established with limited growth opportunities. It is common for value stocks to pay a dividend. Technology companies are a popular growth sector, whereas value stocks are dominated by financial and energy companies.
With technology companies driving the markets higher, value stocks appear to be getting left behind. Through the first week of September, the Russell 1000 growth index (representing 1000 of the largest growth U.S. stocks) returned 20.89% for 2020, whereas the Russell 1000 value index has returned -11.05%. Value stocks appear to be undervalued relative to growth stocks at a level not seen since the dot com bubble of the early 2000s. This is unusual but does not necessarily signal a reversion to the mean is imminent, as a low rate environment tends to be more supportive of growth stocks. Furthermore, Covid-19 pandemic has accelerated broad trends within the corporate world, which benefits some of the biggest names in the technology sector. Unlike the ill-fated companies of the dot com bubble, today’s technology leaders have growing sales, real earnings, healthy margins, and cash-on-hand.
Another unusual development is occurring within the bond market. The low rate world of the past decade looks attractive compared to the even lower rate world we are currently in. With the Fed recently indicating they intend to hold rates down through 2023, today’s low rates may be with us for some time. This puts U.S. Treasuries in an unusual position. When there is an equity selloff, investors often flee to the safety of U.S. Treasuries. February and March were no different, with the yield on the 10-year treasury falling from 1.63% on February 12th to a low of 0.49% on March 9th. Treasury prices move inverse to their yield; as investors pile into treasuries, the yield drops and, the price increases. The 10-year yield has recovered to a paltry 0.69% and remained near that level for most of the summer. Analysts warn that treasuries should not be expected to provide the same level of protection against equity selloffs as they previously have. With the Fed indicating they would not take rates negative; the yield can only go so low (and the price so high) before hitting its theoretical limit. In addition to this, the risk-reward has become asymmetrical; the upside appears capped, but the downside is not. Should rates begin to move higher, the decrease in price could easily be more than all the interest one would receive if they were to hold the treasury to maturity.
These circumstances are setting up an environment where investors may need to reset their expectations. Investors should recognize that the market cannot rely on large technology companies to drive returns indefinitely. At some point, growth stocks will take a breather and, value stocks will draw attention. It is also imperative for investors to recognize that the bond market’s ability to cushion a portfolio against an equity selloff will be substantially limited relative to their history. With yields so low and with little room to further decline, their use as ballast is constrained. We continue to support active management, who are able to seek out opportunities in overlooked pockets outside of crowded trades.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. Although general strategies and/or opinions are revealed, this post is not intended to, nor does it represent or reflect, transactions or activity specific to any one account. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All data and information is gathered from sources believed to be reliable and is not warranted to be correct, complete, or accurate. Investments carry the risk of loss including loss of principal. Past performance is never a guarantee of future results.