- Fed Chairman Jerome Powell telegraphed the next 2-3 years of US monetary policy: as accommodative as possible for as long as possible. Analysts now believe the Fed will keep the overnight lending target at 0-0.25% until 2023.
- It was another good quarter for stocks, despite the sell-off in September. There is still a lot of money sloshing about the financial system that ultimately has to go somewhere.
- Corporate America posted better than expected profits during 3Q. While expectations were diminished, a win is a win…especially in a year like 2020.
- At first blush, the expiration of much of the CARES Act on July 31st did not negatively impact the economy and the markets as much as originally feared.
- The political discussion increased as the quarter progressed. The two political parties currently offer two very different views about the nation’s economic future.
- Bond yields are so low, it is hard to make a strong long-term argument for the asset class. But for the Federal Reserve, and other global central banks, backstopping the secondary markets, you would have to wonder where interest rates would really be.
- The US economy and markets enter the 4th Quarter in ‘improved health,’ but still not completely healed.
3rd Quarter Commentary
At the start of the 3rd Quarter, Oakworth’s Investment Committee made several predictions for the quarter. Here are a few of them:
- After a better than expected 2nd Quarter, investors will be anxious to see how the economy responds when various relief packages start to expire towards the end of the summer.
- The 2nd Quarter earnings season should be interesting given the lack of forward guidance corporate America has been giving. As long as it isn’t a ‘worst case scenario’ and forward guidance isn’t a disaster, investors could move past it more quickly than you would imagine.
- As the quarter progresses, investors will increasingly turn their attention to the November elections. If the Republicans can hold the Senate, the economy is ensured another 2 years of gridlock, no matter what happens with the Presidency.
- The recipe for growth is in place: low energy prices, low interest rates, and expansionary monetary and fiscal policies. However, another mandated lockdown of the economy will render that irrelevant. Our elected officials have to be extremely careful
- Two things are certain about 3Q: (a) stock market returns won’t be as strong as 2Q’s historic ones, and;(b) we will have a better sense of the economy’s true health by the end of the quarter than we have at the start.
These were mostly directionally correct. Things continued to get better during the quarter. Even so, here at the start of the 4th Quarter, it is still difficult to completely ascertain the economy’s true strength.
What isn’t uncertain is the US economy is in better shape than it was at the end of the 1st Quarter and start of the 2nd. Virtually all major economic releases reflect a meaningful increase in activity since the near stoppage at the beginning of the year. While there have been some changes to consumer behavior, the biggest impediment to growth is continued government-mandated interference in the free functioning of state & local economies. These include travel restrictions and quarantines, store and restaurant capacity limits, stringent public gathering guidelines which inhibit industries like amusement parks and museums, and a host of other local ordinances too numerous to list here.
To say we are operating on less than all cylinders would be an understatement. However, this doesn’t seem to be the fault of the private enterprise system. Government lockdowns caused the economic collapse, and continued government restrictions inhibit its rebound. Even so, objectively, some of the results have been pretty impressive given the shackles remaining on the business community.
Consider the following graph from Bloomberg. It shows the number of US payroll jobs. As you can see, these plummeted earlier in the year as governments shut their economies. However, as a partial remedy, the CARES Act helped to reverse the trend. Before anyone argues the government saved the economy, please remember the relief packages were necessary because government(s) closed it. Regardless, we have seen notable job growth over the last several months.
US Nonfarm Payrolls
As a result of this job growth, the official Unemployment Rate has fallen dramatically since the Spring, from 14.7% in April to 7.9% at the end of the quarter. Perhaps even more impressive than the decline has been the fact it hasn’t been due to a sharp drop in the number of Americans looking for work, up until now. To that end, the Labor Force Participation Rate, the percent of working-aged, non-institutionalized people actively participating in the workforce, has increased substantially since the end of April, the nadir in the labor markets, even if it did pull back a little in September.
While there is still plenty of room for improvement, the recent decline in the official number of unemployment has been significant. While most everyone by now has heard the term ‘V-shaped recovery,’ the chart here would have to be called a ‘lambda-shaped improvement!’
US Unemployment Rate
Of course, I would be remiss if I didn’t mention the Federal Reserve.
inarguably more than any other public institution, it has done more to ensure the adequate flow of money through the financial system. The thought process is pretty simple even if the comments Fed officials make can be obscure: good things tend to happen in the economy when the credit markets are liquid and the money supply is growing. While we are supposed to say things like “past performance is not indicative of future results,” the Fed knows its history. The last thing this group of Fed Governors and Presidents want to do is tighten the money supply and run the risk of throttling the economy. So much so, Fed Chairman Jerome Powell has basically told the markets they/he intend to keep interest rates as low as they can for as long as they can, possibly out through 2023. Further, it isn’t going to shrink its balance sheet anytime soon. The foot is on the gas and will remain there, even if inflation picks up a little.
Consider the following charts which shows just how much excess liquidity/reserves the Fed has recently pumped into the financial system. It has been astounding, and history will likely record it as either heroic or foolhardy.
Size of Federal Reserve Balance Sheet
All this money sloshing about and even the partial reopening of state & local economies has consumers and business owners feeling much better than they were. Sentiment has improved dramatically. So much so, you have to wonder what would happen in the economy if the government removed all pandemic-related restrictions. Of course, the number of COVID-19 cases would escalate, and that clearly wouldn’t be a good thing. However, at what point is the cure for virus worse than the disease itself? If the next two charts suggest nothing else, it seems America is ready to get back to work.
Conference Board Consumer Confidence
That is the consumer. US business owners are also feeling a little spring in their step. Consider this: the last reading for the NFIB Small Business Optimism Index climbed back over the 100 level in September to 100.2. That is 4.3 points higher than the trailing 10-year average! Just take a look at the graph. Interestingly, it doesn’t seem as though small business owners are focusing too much on what is becoming an increasingly contentious political environment.
NFIB Small Business Optimism
So, if consumers and business owners are feeling better about things; if the Federal Reserve is doing whatever it can to keep the proverbial economic wheels greased, and if the economy is responding well to the lifting of economic restrictions, how are investors feeling? Was it a good or bad quarter? It couldn’t have been as good as the 2nd Quarter, which was literally historic, and it wasn’t. However, US investors made money during 3Q! When the dust settles, the smoke clears, and the cows come home, that is ultimately the name of the game. Valuations? Earnings? Rationale? These all matter, but investors’ confidence that things will get better is a powerful force.
S&P 500 Price Level 3Q 2020
In the end, the 3rd Quarter of 2020 was pretty much as advertised. The markets were positive, but not as positive as they were the previous quarter. We know the economy is stronger than it was, and that Americans are ready to get back to some semblance of normal. However, we don’t know when the politicians will completely relax the reins.
In so many ways, it reminds one of the first two lines of the refrain in the classic Beatles tune “Getting Better.” While it didn’t chart, as many of the songs everyone knows on Sgt. Pepper’s Lonely Hearts Club Band didn’t, you know the lyrics:
“I've got to admit it's getting better (Better); A little better all the time (It can't get no worse)”
At least that is how we ended 3Q 2020. Better, a little better all the time. After all, it couldn’t have gotten much worse. Right? Well, we shall see what happens with the upcoming elections.
Third Quarter Equity Review
By: David McGrath
The roller coaster ride that is 2020 continued in the equity markets during the 3rd Quarter. July and August produced more incredible returns, but September was the first negative month since March. Combined, we finished with solid positive results across the equity markets for the 3rd quarter.
The top performing sectors for the 3rd quarter included Consumer Discretion (+16%), Materials (+13.4%) and Industrials (+13.1%). The Consumer Discretion sector’s performance was led by Amazon, Home Depot, Lowe’s, and Nike. All 28 stocks in the Materials sector of the S&P 500 showed a positive return. Finally, in Industrials, someone had to deliver all those online purchases that consumers made. UPS (up 50.8%) and FedEx (up 79.9%) were the boats that lifted the tide for the rest of the sector.
The sectors with the worst performance for the quarter were Energy (-20.2%), Real Estate (+1.4%) and Financials (+4.45). Financials have suffered from: 1) extremely low interest rates; 2) the reality they are likely to stay low for the foreseeable future, and; 3) the need to increase loan loss reserves. For its part, the Real Estate sector is dealing with a fast-changing retail landscape that is likely going to need a lot less brick & mortar in the future. Also, more people will work remotely moving forward, and that will dampen the demand for office space. Even so, the results for these two sectors were still positive.
We have often asked clients, if they think they will consume more technology or less in the next decade, and the tally is, you guessed it, 100% more. Now, does that mean we want to go all in on the sector? Not necessarily, but it is a tailwind. The fears with the sector remain more around regulation and the political impact on the big names; however; to put it simply, we think the technology sector will continue to expand over the years to come. Sure, it will have bumps and bruises along the way; however, the innovation, growth, and demand are, and will be, constant themes.
All this being said, the upcoming elections are throwing a real wrench in everyone’s prognostications. Our recent serial about the election, entitled ‘The Election Projection,’ hopefully shed some light on our thought processes, and I hope this piece has as well. One of the highlights from the series is a table which outlines our potential economic sector weightings depending on the political landscape. These are:
So, as you can see, our Investment Committee will have its work cut out for it during the 4th quarter, or could as the case may be. Unfortunately, we have simply had too much discussion about the potential alternatives to include them all in this piece.
Election Series Synopsis
By: Sam Harris
In our latest Thought Leadership series, The Election Projection, the Oakworth Investment Committee explored the possible scenarios on the other side of November’s election. While also focusing on congressional seats up for grabs, the team analyzed four potential outcomes, and how each would impact future macro-economic activity, and, in turn, their impact on the capital markets.
In short form, the crux of the matter relies on Democrats assuming the offensive, sweeping the Congress and assuming control of the Oval Office. Republicans in the Senate must defend 23 seats, whereas the Democrats only 12, clearly granting the advantage to the latter. This scenario, the proverbial “Blue Wave”, would send into motion the most significant changes felt by markets.
Although all four scenarios are perfectly in the realm of real possibilities for outcomes, we felt, as things stand today, the event of a Democrat in the White House and a Republican maintained Senate to be the most likely end result. Joe Biden’s compelling lead in most swing states’ polls, combined with Republicans across the board fighting tooth and nail for their Congressional positions in the two-person-a-state legislature, equates to the strongest likelihood of actually happening.
What does this mean for your portfolio? Frankly, probably not a lot. A majority Republican senate would serve as a roadblock to the more ‘progressive’ of the Democrats initiatives. For example: it would be difficult for them to make significant changes to existing tax law. It would, in all likelihood, stop or at least slow a “Green New Deal”. And, in lieu of recent events, heaven only knows what would happen if a Supreme Court seat opens in the next two years! Pickett’s Charge? The Charge of the Light Brigade? Though we would be inclined to suggest a more defensive positioning, this scenario would surely warrant a more aggressive posture as compared with the “Blue Wave” (the most defensive, from a portfolio outlook, of all scenarios).
In our estimation, the most bullish scenario would be a both Republican White House and Senate. This is, basically, the current status quo. In fact, it would largely emulate that of the past four years: it seems time is a flat circle, and it would be déjà vu all over again. This result, even with a majority Democrat-elected House, would allow for the fastest and largest expanding economy of all the scenarios while also adopting some progressive notions.