Quarterly Commentary - Q4 2020

APW Investment Committee Q4 2020 Commentary

 Q3 Review

The third quarter of 2020 continued the US equity rally started after the bottom in March. The S&P 500 reached break even for the year and even achieving a new all-time high close price of 3,580.84 on September 2^nd.

Continuous Federal Reserve action to maintain financial market liquidity supported all asset prices during the quarter. In particular, high growth technology stocks experienced a surge in September reminiscent of the late Nineties “dotcom” boom driving overall market price-to-earnings ratios to twenty plus year highs.

sectors due to Coronavirus – Energy, Financials, Industrials, Real Estate, and Utilities – while employing millions of people, only represent 25.7% of the index. Technology by itself represents 28.2% of the index. Other areas such as Consumer Discretionary, Communication Services, Health Care, Consumer Staples and Materials that make up the rest of the index are all doing well (positive to very positive for the year). This is the reason that the overall market (i.e. S&P 500) can rise while the economic data continues to be extremely challenged – 25% of a bad number plus 75% of a good number is still a good number!

International stock markets have rebounded as well although not as much as the US. The biggest development in the quarter is the continued decline in the US dollar relative to a basket of foreign currencies (about 8% from the recent peak in March). This is supportive of international stocks for US investors.

On the fixed income side the yield on the 10 year US Treasury note stayed flat during the period. A slight rise in the first week of October puts the yield at 0.76% as of this writing vs. 0.69% on July 1. During the quarter the Federal Reserve Chairperson, Jerome Powell gave speeches that expressed a strong likelihood that the Federal Funds rate

would be kept at zero through 2023. While long-term rates (10 year maturities and greater) could start to rise if the markets see inflation, Powell said they “do not see inflation rising to its 2% target until 2023.”

APW models reflected the strong gains in the stock market with the equity sleeve in our models rising over 12% during the period and the fixed income taxable sleeve growing slightly less than 2%.

Model Changes

• Sale of Vanguard Real Estate Index ETF (VNQ) across all models. General concern about the issues in the hotel, retail, and office sub-segments led the investment committee to determine that performance headwinds are likely to persist. There is even the potential for major structural changes in the office market that could last for years as the work from home movement gains popularity. Note, we do expect the bulk of office workers to return to the office once the virus is under control. Nonetheless, even if 10% don’t, this presents employers with the opportunity to significantly reduce lease costs and therefore the growth potential for office REITs is reduced.
• Exchange of Pioneer Multi-Asset Ultrashort Income Y (MYFRX) with Vanguard Short-Term Bond ETF (BSV). Given the proclamations by the Federal Reserve regarding short-term rates not rising anytime soon, the investment committee felt the most significant risk to bonds is the credit quality of the underlying companies during a difficult recession (or even a double-dip recession).  In the Vanguard Short-Term Bond fund an opportunity existed to extend durations (2.76 years vs 0.36 years) and cut fees (0.05% vs 0.44%) while improving credit quality (74% vs 40% AA or better).
• Introduction of 3% exposure to iShares Gold Trust ETF (IAU) to our moderately conservative and conservative portfolios. While we are generally not believers in gold as a long-term hold due to its lack of income/earnings, the investment committee felt that given the very low rate of interest, the cost of holding gold as a hedge in the portfolio was minimal. In addition, the modest but non-zero probability of a completely out of control election meant that a small exposure to “catastrophe insurance” felt warranted.

Outlook

In our last market commentary, we expressed a somewhat optimistic outlook for the third quarter with the belief that Congress would (in an election year) avail itself of the chance to shower voters with stimulus money. While the stock market did in fact continue to rise, the stimulus never materialized. With the election less than 30 days away it seems that any pre-vote stimulus will be small in nature if at all. Nonetheless, we maintain our bias towards upward equity prices. There are three potentially significant catalysts in the fourth quarter.

• A large post-election stimulus bill.
• A significant and clear victory by either party leading to either more tax cuts (Republicans) or a very large infrastructure plan (Democrats).
• Strong Coronavirus vaccine Phase 3 results and an aggressive plan to distribute.

A few other potentially positive pieces of news include strong corporate earnings and/or earnings outlooks for 2021 and general improvement in the tone and tenor of trade relations with China post-election.

With these as the back drop we, like everyone, share a few common concerns – that the election will be vigorously contested well into January, that Coronavirus cases dramatically increase in the cold weather, and/or that vaccine test outcomes are poor. Any of these could derail stocks. Nonetheless, with the Federal Reserve providing unlimited liquidity, it would seem that the old adage, “Don’t fight the Fed” is still the truest of all investing axioms.

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