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September 2020 | Equity Commentary

Published on Oct. 9, 2020

September 2020 | Equity Commentary

Market Overview

Overall, markets enjoyed a strong third quarter, with the S&P 500 returning close to 9% for the period. While July and August saw robust gains, the index closed out the quarter on a weaker note, falling nearly 4% during September. In our view, this reflects an economy which is transitioning from a strong rebound phase following the pandemic-plagued second quarter, to a slower, more normalized pace. With the election just around the corner, the political environment remains highly uncertain and volatility is elevated. We continue to believe that a balanced, well diversified portfolio is the best way to navigate today’s capital markets.

Recent economic data releases have generally been favorable, in our view. The housing market continues to be robust. The NAHB home builder survey and pending home sales recently hit all-time highs, and existing and new home sales are at their best levels since 2006. We do think that low housing inventories may be a constraining factor going forward, but for the moment the market remains quite strong. Consumer confidence is also strengthening, as both the University of Michigan and The Conference Board indicators for September came in at the best levels since the pandemic hit the U.S. We are also seeing continued improvement in the automotive industry, as vehicle sales have exceeded expectations every month since April.

Other releases have been more mixed. September manufacturing surveys indicate that growth may be moderating as both the ISM and Markit surveys came in below consensus expectations. However, they remained in the mid-50s range, a healthy level, in our view. ISM’s service sector reading for September looked relatively stronger, as it surprised to the upside and came in near its post-pandemic high. The September jobs released is appointed, as job creation slowed to about 661,000 for the month. However ,much of the decline was in government employment, while the private sector fared better.

We believe these indicators collectively suggest that the economy may now be in a transition phase, perhaps regressing back towards the low single digit GDP growth that has been typical in recent years. We expect that GDP growth for the third quarter will be exceptional, but certainly not sustainable, as it will reflect there bound from the historically weak second quarter. Therefore, the recent deceleration in job growth and manufacturing should not be viewed as anything beyond what one would normally expect from an economy which is transitioning from a sharp rebound phase to a more normalized, lower growth environment.

The Federal Reserve held its latest FOMC meeting last month, and our takeaway is that the committee was dovish on interest rates, but perhaps less so with regards to asset purchases. On rates, the Federal Reserve noted its intention to maintain its current stance until maximum employment was reached, and inflation was on track to exceed 2% for a sustained period. Given that the committee doesn’t expect these conditions to be met until the latter part of 2023, the implication is that interest rates are likely to remain near zero for the next couple of years. There was some disappointment, however, that the Federal Reserve did not provide additional guidance

around its pace and scope of asset purchases. We think that it’s possible that committee members refrained from doing so to maintain pressure on Congress to pass another stimulus bill. Inaction may also reflect a view that further monetary stimulus is less impactful while new U.S. cases are elevated, which might push the Federal Reserve to conserve its firepower. Still, we do expect that should the economy weaken, that the Federal Reserve would ultimately ramp up its asset purchases, so as to advance its mandate of promoting maximum employment.

Typically, at this point early in an economic recovery, we would expect small cap, value, and cyclical stocks to be leading the market, but for the most part this has not been the case. We think that the reason is the high degree of uncertainty in the current environment, given the turbulent political landscape as we approach the election, and the persistence of COVID-19. On the former, the uncertainty has only increased with the recent passing of Justice Ruth Bader Ginsburg and the on going attempt to confirm her successor on the Supreme Court, and President Trump’s hospitalization for the coronavirus. Moreover, with COVID-19 case counts again on the rise across much of the country, it remains possible that economic activity will continue to be impacted. In this regard we note that several states are currently in the process of reversing prior re-openings due to worsening coronavirus conditions. On the other hand, we are optimistic that an effective vaccine would give a material boost to economic activity and market sentiment.

We do expect that at some point, should these risks moderate and the expansion prove sustainable, that these aforementioned sectors of the market will begin to out perform. A successful passage of an additional stimulus bill would also likely benefit these types of stocks disproportionately, in our view. However, we believe that the most prudent strategy to navigate these turbulent currents is to take a diversified, balanced approach. We continue to own shares of companies that we expect should perform well as economic growth recovers, but we also maintain positions in companies that we think would be relative out performers should rising COVID-19 cases necessitate further shutdowns, resulting in weaker economic activity.

As of September 30, 2020

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