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Midyear 2020 Market Commentary From the Desk of the CIO


2020: An Unpredictable Year

The Bigger Picture:

Back in early March when the U.S. began to confront the effects of COVID-19, the thought was that a quarantine would last, at maximum, two weeks. “Bending the curve” for 14 days would be all our country would need to slow the pandemic and get on with our lives.

At the time, no one could have gauged the comprehensive global impact of COVID-19, but even then we predicted the virus would cause more economic damage than physical -- and we were right.

As the economic data began measuring the effects of the quarantine, the U.S. found itself in the worst condition since the Great Depression. Unemployment and GDP (contraction) reached levels not seen since the 1930’s. Thankfully, employment and economic activity have improved significantly, and certain sectors are quickly returning to pre-COVID-19 levels. Of course, there are large portions of the economy (travel, leisure, gaming, dining, industrial, aerospace) that will take years to recover. Too many small businesses, which account for two-thirds of all jobs and large portions of wealth, will never return. Similar to post-9/11, it will probably take a full three years to clearly measure the final economic result.

The Federal Reserve continues its liquidity programs, in effect, writing a blank check to all financial and lending institutions. In doing so, credit markets have greatly relaxed. This was the right move at the right time, no small feat for any organization. For this, the Fed gets an A++ for its swift, decisive and useful actions. History has shown that most severe market declines/recessions/panics are caused by a lack of liquidity and available credit. That the Fed was able to dampen that panic while in the eye of the storm will place Chairman Powell in legendary status.

The past five months have felt like a drama in the most interesting of times. The predictions and expectations of financial “experts” have been so wrong they might be laughable, if they weren’t so costly. In asset allocation, stocks, bonds, interest rates and economics – time after time – prevailing wisdom or sentiment has been incorrect. This is not an unusual phenomenon. In fact, our investment group typically monitors and contradicts this noise. What is unusual is both the size and speed of these inaccurate forecasts.

Most recently, the missed prediction of the year award goes to all who thought May jobless claims would rise by 2.5 million, and result in a 19.4% unemployment rate. Instead, jobless claims declined by 4 million and the unemployment rate was reported at 13%. This better-than-expected news propelled the stock market to a level of unchanged – not a typo – for the year. Some technology indices and stocks have actually made all-time highs.

Bloomberg reported on June 8 that forecasts from Wall Street strategists were lagging the actual market by the biggest amount since 1999. While the year is far from over, it demonstrates how difficult it has been to base investment decisions on future economic, corporate or political outlooks.

Compounding the confusion have been the actions of systematic/algorithmic/computerized trading strategies, which manage trillions of institutional dollars around the world and have accounted for recent exaggerated market moves. While J.P. Morgan estimated over $2 trillion in equities were sold in March by these “quants,” there is now closer to $1 trillion waiting to be invested. Is this a positive or negative for the market? It could be both. It’s hard to know what the next quant move will be since they work from different algorithms, but upside moves can be exaggerated in the same manner as the downside.

A Closer Look:

The equity markets continue to amaze and confound in so many ways that it is difficult to annotate. Even then, which market are we talking about? For the first half of the year ending June 30, returns among the various market indices were quite mixed: Dividend-heavy Russell 1000 value index (-16.26%), small cap index Russell 2000 (-12.99%), DJIA (8.43), world index MSCI ACWI IMI (-7.06%), S&P 500 (-3.09%), and the winner - NASDAQ….wait for it…a whopping +12.74%!

This illustrates an important point: A rising tide does not lift all boats. Sector and security selection will be essential for investment success. Active managers will now have a terrific opportunity to demonstrate value added above and beyond a passively managed strategy.

As of June 30, the S&P 500 recouped 62% of the loss from the March 23 bottom. This is an important technical indicator suggesting the market may move higher. Maybe it does…or maybe poor economic fundamentals keep a lid on the upside. Either way, unless an investor became a trader for 60 – 75 days, they could only have captured this “clawback” through staying invested.

“Crosscurrents” might be the correct adjective for today’s market environment. On one hand, many institutional investors have been holding far too much cash while the market has risen 20+% (by definition, this begins a new bull market!), so they are starting to throw money at this level. This includes buying the “trash,” those severely beaten-down stocks that might improve as the economy improves. On the other side, there are those who see current business fundamentals dramatically lagging stock prices and do not see investment opportunities, only overvaluation. China tensions and the impending election are also causing anxiety for those investors.

The AWM&T Approach:

This market environment has certainly reinforced a number of our investment management principles:

1)      Don’t try to predict, just go with what the market gives you.

2)      Avoid the noise from “experts.”

3)      Do your own homework.

4)      Crosscurrents/chaos/volatility provide great opportunities for active managers.

5)      Stay disciplined, objective and humble.

AWM&T rebalanced portfolios in late March, by selling fixed income and buying equities. It resulted, after the strong rebound, in many portfolios being too heavily weighted in equities. Portfolios, once again, are being rebalanced back to target allocation, as needed. This was the right move for our clients, as it demonstrated how well our investment discipline works during times of great stress.

In addition to rebalancing, AWM&T’s other focus was on sector and security selection. For all three of our investment styles, we are emphasizing companies with strong financial statements and executive management, good product pipelines and expanding operating margins. The emphasis is on growth – at a reasonable price (known as “GARP”).  Stock portfolios selectively upgraded during the quarter, adding Boeing in place of PNC, for example, and dividend-focus accounts added Qualcomm in place of PNC.

Our fixed income portfolios began the year significantly trailing their benchmark, due to our very conservative approach before the “Covid Crash.” Then, while the rest of the world, literally, made their way to the intermediate term U.S. Treasury market, AWM&T stayed on the sidelines until the corporate bond market reached a level of panic not seen since 2009. In late March and early April, we sold our short-term bond positions and purchased intermediate-term corporate fixed income at bargain prices. This has allowed us to dramatically close the gap with the bond index benchmark, in a sensible, risk-averse manner. Our portfolio risk/return profile has been upgraded due to the selective and timely exposure in the intermediate investment grade area.

What an interesting year! What a great year to be alive and see history in the making. The anniversary of my 40th year in the industry has certainly provided more fireworks than I ever imagined. And there are still six months to go.

There is still much in flux: COVID-19 part II, relations with China, the pace of small business recovery, consumer strength and, of course, the election. To what extent and how much – if at all – these events could impact the markets provides a high level of speculation unto itself. If history has taught us anything – and continues to teach us today – it’s that the U.S. economy and financial markets are resilient and profitable over time. Sometimes that takes three years; other times it only takes three months. The only way to capture those moves is to stay invested.

While the remainder of the year will have its usual challenges, AWM&T has performed well during one of the nastiest bear markets in history. Our philosophy of long-term investing, using a disciplined methodology and an objective view of security selection have all added value during this period of uncertainty, and will be essential as we look to the second half of the year.

For additional commentary and insights, please listen to my recent webinar "Midyear Market Commentary."

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