“What’s natural is the microbe. All the rest — health, integrity, purity (if you like) — is a product of the human will, of a vigilance that must never falter. The good man, the man who infects hardly anyone, is the man who has the fewest lapses of attention.” Albert Camus, The Plague
As we head into next week, many are concerned about how the market will respond to a potential Biden win, especially if the Democrats also win a Senate majority. It is conceivable it will have a positive economic effect, particularly with increased stimulus. We continue to believe fiscal stimulus and monetary policy have a far greater impact on our economy (and stock market prices) than political rhetoric, even though political discourse dominates the news. However, we do expect volatility to continue and are ready to adjust if conditions materially change.
Virus—The above quote from Camus is timely. Those who have read The Plague will also recognize his metaphorical intent as he addresses any contagion that overtakes any society, whether it be a virus or a corrosive ideology. Our government cannot control the fact that COVID-19 exists. It also cannot control our psychological response to changes, even without lockdowns. With no lockdown in Chicago, the city business districts still have drastically lower foot traffic. Mass transit ridership is down at least 90%. Even without restrictions, Americans (mostly) have greatly reduced indoor activities related to dining, shopping, weddings, church services, travel, etc. COVID-19 related intensive care patients as well as last ditch respirator use are beginning to reach capacity limits in some areas with large case spikes. While therapeutics and recoveries have improved since March, that is concerning as we move into the fall flu season which will see many more deaths. Collectively, most of us are much more careful to avoid contracting and spreading the virus even in the absence of restrictions. For perspective, this virus may end up killing more Americans than WW II and people are acting accordingly. The result of behavioral changes, even when not forced, point to a slow, uneven recovery.
So how will this scenario play out in our economy? There are factors offsetting the bad news. Some sectors are not nearly as affected as others. Many corporations and investors who were fortunate enough not to be in sectors most affected by the virus have significant amounts of cash and savings rates increased due to decreased activity due to restrictions or behavior changes. Extraordinarily large stimulus efforts (with more to come) should provide a bridge to safely getting on the other side of the pandemic. The key in the coming months is to get cash into the hands of those who need it most.
- Stock market values relative to GDP were recently at highs reached only 3 other times:1928, 1999, and 2008.
- Growth stocks (primarily driven by large tech) relative to value stocks are historically expensive. Historically, value stocks have outperformed growth, yet the last 11-12 years have been one of the best periods for growth stocks. At this extreme level, it is an entirely reasonable to think value will outperform growth over the next 10 years.
- Technology stocks now total over 30% of the S&P 500 with just 5 companies comprising over 25% of the index at its peak. Many other asset classes are still significantly below highs reached in February 2020.
- US stocks versus international stocks are at a price premium based on earnings at a level last seen 40 years ago.
The next 10-12 years will most likely look significantly different than the last 10-12 years.
Economic Record of Current Policy
In 2018, we wrote about expected negative effects from starting a trade war with China. Manufacturing employment peaked shortly after Trump’s action. Unfortunately, the trade deficit has not been solved and the action likely contributed to a decline in U.S. exports.
The tax cuts were supposed to pay for themselves by boosting economic growth above 4%. A good business will borrow money to expand if the expected returns are higher than the cost to borrow money so theoretically, this could be a good idea to boost economic growth. So what happened? We increased our deficit to 4.3% of GDP before COVID-19, yet growth was not over 3%. The cuts did not pay for themselves and the deficit was increasing at an accelerated rate before the pandemic.
Economic growth in the last quarter was 33%, fantastic, but still a ways off from recovering losses of over 35% in of the first 6 months of the year. The math is simple in measuring the recovery by percentage: If you start at 100% and lose 50%, you then need a 100% increase to get back to where you started. Less people are working now and continued high unemployment will drag economic growth significantly – for context, there are more unemployed Americans now than at the worst level of the 2008 decline. The hardest hit sectors of our economy need more help and should absolutely be the focus of additional stimulus efforts. There are already signs of slowing growth heading into the fourth quarter following the large 3Q rebound.
We feel the following trends will be in place in 2021. We are positioned accordingly but recognize the situation could change and we will have to make adjustments.
- We will get a substantial stimulus bill that will help provide a safety net for those most affected economically by COVID-19 job losses and support economic recovery
- The Federal Reserve will work to keep interest rates low in an attempt to prevent deflation and support economic growth
- Value stocks will start to outperform growth stocks
- The dollar will weaken and international stocks will look attractive
It has been a trying year for many. Unexpected virus and intervention we have not seen in the past to support the securities market, otherwise we could have had a stock market crash and banking crisis exceeding the 1929 crash.
Please reach out to us with any comments or concerns. We will see how this next week plays out and provide an update next Friday.