Nauset Wealth Managment
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Nauset Insights

Nauset Market Commentary – Q1’21

Market Performance Recap: Stocks Up, Bonds Down

Accelerating vaccinations, diminishing economic restrictions and a $2 trillion stimulus led to a strong 2021 opening quarter for the stock market. However, those same elements also drove up Treasury yields, causing concerns about bonds and the tech sector. The good news drove the Russell 1000 up +5.9% in the quarter led by economically-sensitive materials, energy, financials and industrials sectors. US small cap stocks were the best performer for the quarter with a gain of +12.7%. International stocks posted smaller gains of +3.5% for EAFE and +2.2% for Emerging Markets index. Higher yields hurt bond returns, which posted their first quarterly loss in three years at -1.9% per the Barclays Intermediate Gov’t/Credit bond index.

Economic & Market Discussion: Inflation Fear Factor

Most agree we are in an unusual economic cycle featuring a global pandemic, economic lockdowns and massive monetary and fiscal support. As such, there is a large degree of uncertainty regarding the recovery phase, particularly how the upcoming cyclical boom will affect inflation. The fear is that an overheating economy boosts inflation and leads the Federal Reserve to raise rates and thus choke off a nascent recovery. Let’s look at the inflation issue more closely.

  • Boom Time – The US and most major global economies are poised to exit the most severe elements of the global recession later this year. Low borrowing rates and powerful stimulus packages across most developed countries will likely ignite a roaring recovery unlike any we have experienced in over 30 years. Current forecasts point to 2021 US GDP growth exceeding 6%. With rapid growth comes a scramble for resources, goods and services that will most likely lead to price increases. The question is what level of inflation might we expect and for how long?
  • Temporary Spike? – We agree that US consumer prices will rise as demand for goods and services surges later this year. However, we also agree with PIMCO’s forecast (chart below) that the rise in US inflation will be temporary. Here’s why: While consumer prices will most certainly rise, we believe full employment will prove elusive as companies incorporate more automation and digitization into their processes. We expect that will dampen inflation following a temporary price run-up. Moreover, the chances of the Fed raising rates quickly to combat even a temporary inflation spike are unlikely as they have stated they will let core inflation run above 2% for at least a year before any rate increases.

  • New Opportunity Set – While we don’t foresee a new higher level of inflation persisting into 2022 and beyond, financial markets will likely focus on elevated inflation fears in 2021 and thus create volatility in the bond and equity sectors most sensitive to rate risks. We will look for new opportunities amid this anticipated volatility to add to our favored positions across the portfolio. At the same time, we are mindful that inflation risks can persist and central banks can make policy mistakes. So, we will monitor the inflation situation closely as the economy ramps up in the next several quarters.

Portfolio Strategy: Base Policy Changes

Our current investment strategy is based on our view that easy money policies and positive earnings growth will continue to support stocks in 2021 despite volatility and full valuations. Within this strategy, we are favoring specific classes and sectors that we believe will benefit from the recovery growth scenario.

  • Overweight Mid & Small Cap Stocks – In a shift from 2020, we believe the economic recovery will have a relatively larger positive impact on mid and small cap stocks over large caps. Therefore, we have increased our equity weighting toward mid and small caps in most portfolios.
  • Sectors Focus – We added equity exposure to the financial sector in the first quarter. Along with the industrials sector, we feel these two economically-sensitive areas will benefit as the expected recovery accelerates. We continue to hold tech and healthcare overweights in this environment. Even though these sectors may not enjoy a short-term advantage, we believe both provide attractive long-term value.
  • Staying in Balance – Investors have focused on high flying stocks during the past year. While we share that view, we have kept portfolios balanced with allocations to bond, real assets and alternative investments to create diversified sources of return and to help manage overall portfolio risk.

Nauset Market Commentary – Q4’20

Market Performance Recap: Stocks Close 2020 on New Highs

The strong stock market rally off March lows continued in Q4 on the news and rollout of two highly effective vaccines. This occurred while the US economic recovery slowed in the face of surging Covid-19 infections. Forward-looking investors drove the Russell 1000 up +13.7% in the quarter to finish the year at +21.0%. Tech and consumer stock sectors outpaced the market, while energy and real estate lagged. US small cap stocks were the big winner for the quarter with a gain of +31.4%, up +20.0% for 2020. International stocks posted 2020 gains of +7.8% for EAFE and +18.4% for Emerging Markets index. Bonds posted a small Q4 gain of +0.5% to finish the year at +6.4% per the Barclays Intermediate Gov’t/Credit bond index.

Economic & Market Discussion: Market Rally Redux?

Investor consensus points to another positive year for the US and global stock markets. With effective vaccines expected to tame the ongoing Covid-19 pandemic, investors foresee a ramp up in the synchronized global economic recovery. Is the optimism justified and what could go wrong?

  • Massive Government Support – The US and most major global economies are being supported by historic levels of monetary support from aggressive bond-buying programs and zero or near-zero short-term rates. Add to that, record levels of fiscal help from commercial loans and grants to direct stimulus checks to individuals. The chart below shows this tremendous economic support as a percent of GDP offered by major governments and central banks around the world.

  • Light Blue Policy – With Biden as the new President, we must consider the prospect of new or changing policy in key areas. We do expect new stimulus programs, as well as indications of potential change in tax, trade and infrastructure policy. While immediate major policy shifts are unlikely given the slim Democratic Senate advantage, these hot button policy issues can positively or negatively impact the ongoing economic recovery and thus the markets. We welcome more stimulus to support the economic recovery, and will closely monitor any policy shifts that might create economic headwinds.
  • Unknown Unknowns – With economies poised to recover and vaccines being rolled out, all signs point to a favorable market outcome. Right? If 2020 has taught anything, it is unforeseen factors and events that roil the markets can and do happen. Given the unusual nature of the pandemic and its impact we feel the current economic recovery is particularly vulnerable to the unexpected. Therefore, we all need to keep in mind that there are a multitude of uncertainties that could derail the economy and the markets as the new year unfolds.

Portfolio Strategy: Conviction with Flexibility

Our base case is that easy money policies and positive earnings growth will continue to support stocks despite current full valuations. We are optimistic for gains in 2021, but will be remain balanced and ready to adjust allocations as we move forward.

  • Stay with Stocks – Even with the strong 2020 results, we believe stocks continue to show favorable relative value compared to other asset classes. Therefore, we will continue to hold slight overweight equity allocations in most portfolios.
  • Tech and Industrial Overweights – We continue to focus on tech and tech-enabled investments across our equity allocations. While some mega-tech stocks may face possible legislation, we believe tech-related investments will continue to provide attractive long-term value, especially during the continued pandemic-induced uncertainty. We have added a new allocation to industrial stocks which we believe will benefit from the expected economic recovery.
  • Maintain Flexibility – As the economy continues its recession recovery, we expect new opportunities to arise. We intend to seek attractive new investments in stock as well as bond areas as they develop during the next several quarters.

Nauset Market Commentary – Q3’20

Market Performance Recap: Stocks Rally to New Highs

The sharp rally of Q2 continued into Q3 with large cap US stock indices hitting new all-time highs before a pullback in September. As the US economy slowly reopened for business, the Russell 1000 rose +9.5% in the quarter and is up +6.4% year-to-date through September. The upswing was once again led by technology, consumer discretionary, and industrial stock sectors. US small cap stocks were positive for the quarter, though not as strong as large caps, with a gain of +4.9%, but remain off -8.7% year-to-date. The non-US MSCI EAFE developed country index gained +4.8% for Q3, now down -7.1% for 2020, while the emerging market index added +9.6% in the quarter and is down only -1.2% year-to-date. Bond prices were steady during Q3 as Barclays Intermediate Gov’t/Credit bond index edged up +0.5%.

Economic & Market Discussion: Gauging the Election Impact

The Presidential election is fast approaching, bringing a rash of fear-inducing headlines. Will the election outcome affect the track of the financial markets? Should we get defensive to protect portfolios from potential policy changes of a new administration? Here is how we view the upcoming political event.

  • Elections Are Usually Positive – For the past fifty years of Presidential elections, the S&P 500 stock index has gained about +4% on average for the three months following a Presidential election. The chart below shows that the market usually drives forward after an election regardless of who is at the wheel. The key takeaway is that Presidential elections are but one factor in determining market direction, and are usually not as powerful as the three fundamental factors we track: corporate earnings growth, interest rates, and market valuations.

  • Manage to Actual Policy Shifts – While much has been written about what each candidate will do post-election, our view is to wait for policies to be enacted before adjusting our asset allocation strategies. In the short term, we expect supportive fiscal policies to continue to help the economy recover from the negative effects of the pandemic. Beyond that, we know that major shifts in trade or fiscal policy usually take time, and are often modified to less impactful new legislation. On the monetary side, the Fed has prioritized employment over inflation which keeps rates low and provides support for market valuations. Therefore, our most prudent course is to be more reactive than proactive with regard to post-election fiscal policy changes.
  • Contested Election Risk – A worrisome development is the potential for a contested election which could delay the final outcome. This scenario would occur if one or more state votes are challenged and subject to review and possible recounts. While specific rules and margin thresholds may limit the actual recounts, any uncertainty will be viewed as a negative by the markets until resolved. Once resolved, we believe investors will move on and refocus on the economy. We will, of course, monitor any such developments closely.

The history lesson on Presidential elections and investments: Elections matter less for markets than most anticipate, so don’t be too defensive in the face of potential political shifts. Instead, focus on the current economic scenario. While today’s pandemic recovery track is unique and uncertain in many ways, we remain positive on the markets and the economy following a victory by either party.

Portfolio Strategy: Optimism Amid Headwinds

Despite market choppiness during the past month and uncertainty regarding new fiscal stimulus, we believe that two key elements will continue to support the markets: synchronized global economic recovery and extremely low interest rate policies. As such, here is how we are managing portfolios going forward.

  • Stay with Stocks – Even with the strong recovery rally, we believe that stocks continue to show favorable relative value compared to other asset classes. Therefore, we hold slightly overweight equity allocations for most portfolios.
  • Quality Rules – Our emphasis for both stocks and income-producing securities is on quality during the continued pandemic-induced uncertainty. We favor investments with a margin of safety, such as large cap US tech and health care stocks, as well as US Treasury and investment-grade bonds. 
  • Maintain Flexibility – As the economy continues its recession recovery, we expect new opportunities to arise. We intend to seek attractive new investments in credit as well as stock areas that develop over the next several quarters.

Nauset Market Commentary – Q2’2020

Market Performance Recap: Historic Stock Bounce Back

The Russell 1000 notched its best quarterly performance in 21 years, rising +21.8% in a strong bounce back from the pandemic-induced market decline in the first quarter of the year. While the Covid-19 pandemic continues to hinder economies across the globe, the strong rally puts the US large cap Russell 1000 index down only -2.8% for 2020. The surprising Q2 rally was led by technology, consumer discretionary and communications stock sectors. US small cap stocks posted an even stronger rally of +25.4%, but remain off -12.8% year-to-date. For international stocks, the MSCI EAFE developed country index gained +14.9% for Q2, now down -11.3% for 2020, while the emerging market index rebounded +18.1% in the quarter and is -9.8% year-to-date. Barclays Intermediate Gov’t/Credit bond index posted another solid quarter with a +2.8% increase.

Economic & Market Discussion: Making Sense of the Market Rally

As US equity markets posted their best quarter in over 20 years, the US economy has struggled through its worst quarter on record. How and why did this happen? And what does it mean for markets going forward?

  • Economic Rebound – Broadly speaking, the market is reacting to better-than-expected economic data as shown in the graphs below and a reversal in unemployment data in May and June. Despite the current surge in Covid-19 cases in many states, the market is supported by the likelihood that there will not be a second nationwide economic shutdown. Also aiding the market upswing is investor optimism regarding vaccine development. While the market may have reacted too strongly and quickly to the positive economic trends, the rebound is underway. Given the strong Q2 stock gains, the market’s reaction to future good economic news may be muted, while any setbacks in the economic rebound would be negative.

  • Don’t Fight the Fed – The Fed has stepped up in a huge way to support the economy by ensuring the mechanics of the credit market and purchasing bonds across several markets. The Fed has also committed to low interest rates for several years. As with positive economic data, the markets have reacted very strongly to the Fed’s easy money policies. In the short term, we expect the Fed to continue to act as a backstop to the bond markets and lessen the negative effects of the pandemic on the economy.

  • Winner, Winner – Another key to understanding the exceptional stock market gains in Q2 is that the largest US public companies, especially tech firms, have been hurt less by the effects of the pandemic than smaller and private businesses. Thus, the earnings of many US large cap public companies should outperform GDP despite the impact of lower aggregate demand. Additionally, accelerating structural changes in the economy caused by the virus are also likely to benefit the mega-cap US public companies.

While the rationale for a stock market rebound is understandable, the speed and strength of the rally may have anticipated a faster economic recovery than what is unfolding. For that reason, we are cautious with respect to further gains in 2020, and markets are likely to experience more volatility as small businesses and schools reopen this quarter. There are plenty of factors to monitor in the coming months. In addition to the usual economic and market data, we are also watching Covid-19 vaccine progress, the Presidential race and social injustice protests. Any of these elements could have positive or negative market impact over the next quarter as the recovery continues.

Portfolio Strategy: Maintaining Balance

Anticipating a V-shaped economic recovery, the US stock market is now fully or slightly overvalued. Keeping with our usual long-term perspective, here is how we managing portfolios entering the second half of 2020.

  • Near Neutral – The market rally and recent rebalancing have placed most portfolios at or near neutral allocations for equities. We expect to maintain that stance unless market conditions drive market levels significantly in either direction, in which case we would likely rebalance back to neutral.
  • Stay with Strength – As a form of defense, we will continue to focus on quality in both stocks and income-producing securities during this period of market uncertainty. We will favor investments with a margin of safety, such as investment grade bond funds, and large cap US tech and health care stocks. 
  • Open to New Opportunities – As the economy continues its recovery amid the uncertainty, we will search for attractive opportunities in credit as well as international and smaller cap stock areas based on valuation.

Coronavirus – Market Impact

After mostly ignoring the potential impact of the coronavirus that originated in China, US markets have suffered a sharp sell-off, as the S&P 500 Index is currently about -8% off its recent all-time high. The fear is the virus may spread more broadly than originally predicted and negatively affect economic activity around the globe.  

This COVID-19 viral outbreak is a very real headwind to economic growth in China, globally, and the US. The extent of the eventual damage is difficult to predict, but it will temporarily lower GDP growth across the globe. The good news for the US is that, while there will be some impact due to disrupted supply chains and reduced exports, the US economy has a solid foundation of low unemployment, improving wage growth and is much less dependent on the rest of the world than most countries.

How bad will the impact be? How much further will the markets decline? Both answers are unknowable at this point. However, we can say the following – until the global outbreak is successfully contained, markets will trade on fear and hope, not on fundamentals of growth and profit. And that will lead to continued volatility.

Nauset’s portfolio strategy has prepared us for this type of volatility with an allocation to securities that provide market buffers. Additionally, our long-term financial planning focus takes into account and anticipates market declines. As long-term investors, we don’t want to make the mistake of trying to call a short-term market bottom or time the market. 

If you’d like to read more about the coronavirus impact, the Independent Market Observer’s article, How Should Investors React to the Coronavirus?, is an excellent piece.