High Level Commentary

MARKET PERFORMANCE-As Of November 20, 2020

Markets have reacted positively to President-Elect Biden and the prospect of a divided government.  Although control of the Senate won’t be determined until after elections in Georgia in January, many are assuming a divided Congress that is less likely to make major policy changes.  Since 1944, political gridlock with a Democratic president and a split congress resulted in an S&P 500 gain of over 13% in the calendar year following the election according to Wharton Finance Professor Jeremy Siegel.  Key goals in a Biden administration include plans for clean energy and infrastructure, raising taxes on high-income households over $400,000 and an increase in the corporate tax rate from 21% to 28%.  The tax increases are described as raising $2 Trillion over a decade.  If the Senate remains under Republican control, these policy goals will be more difficult to achieve.

Performance:  Investment performance continues to be volatile.  Although November has been strong, September and October were the first two negative months since the epic rebound from the March panic.  Small cap stocks have outperformed in the recent past as some of the tech darlings (Apple, Facebook, Google) sold off.  Small cap stocks also disproportionately benefit from an expected stimulus package.  Cyclical companies, especially retailers, would also benefit from additional stimulus going into consumers’ pockets.  Emerging markets have also outperformed recently based on steadier Chinese growth, improving earnings prospects and lower global interest rates.

Although equity markets have been volatile but positive in 2020, longer maturity bond funds have underperformed in the last three months.  Although fiscal stimulus is necessary as we face the COVID restrictions and lockdowns, there is growing concern related to huge government budget deficits.  Investors are less willing to accept historically low longer-term government debt, and this is pressuring long-maturity bond prices lower as yields move higher.

COVID19 and Positive Gains for Vaccines and Treatments:  As of the end of October, there were four companies that were in late stage trials for developing a vaccine.  Pfizer and BioNTech, Moderna, Astra Zeneca with its University of Oxford partner and Johnson & Johnson are all in Phase 3 trials and results are data are expected to be published later in 2020 or early 2021.

Pfizer and German partner BioNTech announced November 8 that their coronavirus vaccine was more than 95% effective in preventing COVID19 for individuals with no prior infection.  This was a very encouraging announcement and production is expected to be available later in 2020 and then increasing throughout 2021.

Moderna said preliminary phase three clinical trials show its vaccine is 94.5% effective.  The results from Pfizer and Moderna showing 90%+ efficacy are very encouraging.  Final clinical results and real-world experience will help determine the ultimate benefit.  A key question regards how well these vaccines work for elderly patients.  Another question relates to how long the vaccines provide immunity before a booster shot might be needed.

Eli Lilly announced a treatment on November 9 that provides a treatment for people in the earlier stages of the virus infection.  This drug appears to be able to keep people from getting worse and needing to be hospitalized.  This is particularly important as hospitals are currently operating at high capacity levels.

Regeneron has an antibody cocktail that is reducing viral symptoms and thus reduces hospitalizations and physician visits.

Gilead Sciences’ antiviral drug Remdesivir received FDA approval October 22.  This drug shortens the recovery time for patients suffering from COVID.

Vaccines and treatments hold the promise of allowing the global economy to get back closer to normal.  Dr. Anthony Faucci continues to express optimism regarding vaccine and treatment approvals, but broad-based utilization still looks more likely by mid-year 2021.  Any Covid-19 vaccine would likely be first used to protect front-line health care workers and elderly who are at most risk to the virus.  Over time, a vaccine would achieve “herd immunity”, whereby the antibodies of the majority of individuals built up, either via exposure or vaccination, are sufficient to protect the remaining vulnerable people.

Virus resurgence-Although vaccines and treatments are making rapid progress, the U.S. and Europe are experiencing high levels of infections.  President-Elect Biden has established a task force, but policy implementation will take time.  Meanwhile, the UK, Germany and France are implementing renewed restrictions and lockdowns.  As a result, European economic growth is at risk of a second downturn.  Until vaccines and treatments become widely available, broad-based testing and tracing needs to be expanded so virus carriers can be identified and isolated.

U.S. Economic Statistics Remain Positive.  Economic statistics dropped precipitously due to the government-induced shutdown, but then rebounded well above consensus expectations.  More recently, however, economic reports are less robust but still remain positive.

-US Third Quarter GDP moved up 7.4% on a quarterly basis, compared to a -9.0% second quarter decline.  This was a reasonably good report, with continuing gains for consumer spending.

-Unemployment (at a 50-year low of 3.5% in February) spiked to 14.7% in April but has since dropped to 6.9% for October.  Although many workers have been called back to their jobs, this unemployment level is still at a high level.  Moreover, initial claims for unemployment insurance, a proxy for layoffs, remain stubbornly high at over 700,000 on a weekly basis.

-Retail sales for April declined 14.7%, the largest decline since 1992 when this data series was initiated. However, May retail sales jumped a record 18.3% on a month-over-month basis, well above the consensus expectation of 7.5%.  Retail sales were impacted by pent-up demand and government checks, but June was also up an impressive 8.4%.  Sales growth has slowed, but October still came in at 0.7%.

-Industrial production advanced 1.1% in October.  This was a solid gain, but Industrial production is still down 5.6% below the pre-pandemic February level.

-Single family housing starts remain very strong as sales of previously owned homes climbed 4.3% in October.  October’s growth marked the fifth consecutive month of growth as sales rose to a 14-year high.  Sales are being driven by ultra-low mortgage costs and a shift in living preferences due to the pandemic.  Affordability may become an issue, however.  The median existing-home price rose 15.5% from a year earlier to $313,000, a record high according to the National Association of Realtors.

-The Leading Economic Indicators came in at a positive 0.7% in October, the sixth consecutive monthly gain.  Before that, the data was negative with March down 7.5% and April down 6.3%. These statistics point to the sudden, large shutdown of the U.S. economy caused by the unprecedented coronavirus pandemic, and then an encouraging uptick.

Two-Track Economy.  Although the U.S. economy is recovering, employment and overall economic activity remain well below pre-pandemic levels.  While manufacturing has rebounded significantly, the service sector continues to struggle.  Lower-income workers have been disproportionately impacted by service sector job losses, and this leads the characterization of a two-track economy.  This economy is also described as being “K-Shaped”, with some groups doing quite well and others trending downward.  There is a clear need for a targeted fiscal stimulus package and hopefully a compromise package can be structured now that we are past the election.

Looming government shutdown.  Current government funding expires on December 11th and another shutdown is possible if a compromise is not achieved.  As in the past, our politicians are expected to kick the can down the road once again.

Market valuations remain rich.  At this point, markets are ignoring weak 2020 corporate earnings, and are trading on expected 2021 earnings.  Nevertheless, various valuation metrics (like Price/Earnings ratios) for 2021 are still elevated.  It is important to remember that valuation doesn’t predict short-term performance, but valuation definitely impacts long-term performance potential.  In other words, markets could continue to get move up on a short-term basis, but the longer-term performance might be a 5-7% average long-term return/year rather than the historic 10%/year return.

Corporate Earnings for the second quarter were down 31.6% compared to last year according to FactSet due to the negative impact from COVID-19.  Revenue was down 9.3%.  Although the earnings reports are down sharply from last year, there are beginning to be upward revisions for the third quarter.  At this time, Q3 earnings are expected to be down 20.5% and revenue is expected to be down 3.5%.  Although earnings remain negative on a year-over-year basis, they are not nearly as negative as previously expected.  Looking ahead, the Factset consensus shows a 22% earnings gain in 2021 compared to the COVID impacted earnings drag in 2020.

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Markets & Economics

Market Performance


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