August 2020 | Equity Commentary

Published on Sep. 9, 2020

August 2020 | Equity Commentary

Market Overview

Stocks continued their ascent during August, as the S&P 500 surged about 7% for the month. We believe that a resilient economy, better than expected corporate earnings, and improving trends in new COVID-19 cases were likely all factors helping to propel the market to new highs. The Federal Reserve most likely buoyed investor spirits by introducing a new dovish policy framework, effectively confirming the prevailing view that interest rates are likely to remain at historically low levels for some time to come.

We were encouraged by the economic data released during August. Most national surveys of the manufacturing and service sectors continued to trend favorably, and the July jobs number came in ahead of expectations with nonfarm payrolls increasing by 1.76 million. The housing market continued to impress us with the latest tally of starts and permits increasing by 22.6% and 18.8% respectively on a month-over-month basis. July new home sales came in at the best level since 2006, and the NAHB homebuilder survey matched a record high. It seems evident to us that extremely low mortgage rates are helping to propel a robust housing market.

We believe while resilient and even quite strong in certain areas, the economy is by no means firing on all cylinders, though that is to be expected amid the COVID-19 pandemic. The most recent Empire and Philly Fed regional manufacturing surveys missed consensus expectations, and the Conference Board’s consumer confidence reading for August declined to its lowest level since 2014. New claims for unemployment have stalled at around 1 million per week, and while this is below recent peaks it remains materially above the pre-pandemic high of about 695,000 reached back in October of ’82. While this raises some questions about the health of the labor market, we do note that total unemployment claims have been trending favorably, perhaps indicating that new hiring has been able to mitigate the stubbornly high level of new claims.

A potential hurdle facing the economy and capital markets is the lack of progress on another stimulus bill. While the Trump administration did attempt to step into this breach with a series of executive actions, it appears likely that legal and operational challenges could minimize their effectiveness. We have seen estimates that these measures will provide less than $100 billion of economic support, compared with expectations for over $1 trillion from an additional fiscal stimulus bill. As a result, there are concerns among investors that the economy may be at risk for another slowdown. However, we have yet to see evidence of this in the economic data.

Federal Reserve Chairman Jerome Powell delivered a notable speech at the annual Jackson Hole Economic Symposium, detailing key takeaways from the central bank’s recently completed framework review. We think the principal message was that the Fed will allow unemployment to fall below its estimate of the natural rate (of unemployment) without necessarily raising interest rates, which previously would have been its typical policy response. It is also moving towards an average inflation objective, a change from its past practice of targeting a specific rate of 2%. It will accept somewhat higher than targeted levels of inflation given that they occur following periods that fell below trend. We believe the earlier Fed will generally attempt to be more flexible with its policy responses in these regards. This new framework was adopted than expected in a unanimous vote by the Federal Open Market Committee. We view these changes as dovish insofar as they can be taken as confirmation that rates are unlikely to be moving higher at any time soon.

Positioning

Growth stocks continued to outperform value in August, as was the case in June and July. While we believe that this trend is likely to shift and favor value stocks as the economy recovers, to date this has not occurred since the market’s rebound from the March low. This may be in part due to the lack of a fiscal stimulus bill, which had it been passed, we believe would have disproportionately benefitted more cyclically oriented companies. Still, we are comfortable with our current portfolio positioning which we believe is well balanced on both a style and capitalization basis. It is our view that small cap companies and value companies are likely to outperform in a positive scenario whereby the coronavirus continues to trend downward, and economic growth continues to recover. Conversely, we would expect larger cap stocks and growth stocks to be relative outperformers should another wave of the virus lead to more lockdowns and weaker economic conditions. We continue to view either scenario as well within the realm of possibility, and therefore believe that our current positioning is the most prudent means of navigating today’s capital markets.

As of August 31, 2020

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