|3rd Qtr Return
|MSCI ACWI Ex USA IMI
|Barclay’s Bond Index
|Consumer Price Index
The stock market recovery continued during the third quarter as the S&P 500 increased 8.9%. This increase brought the market back into positive territory on a year-to-date basis. Small cap companies as measured by the Russell 2000 lagged their larger peers, but were still up 4.9% for the quarter, though they are still down nearly 9% for the year.
Internationally, emerging market stocks continued to outpace developed markets. ACWI Ex USA IMI returned 6.8% during the third quarter.
While intermediate and long term interest rates finished the quarter slightly higher than where they began, there was a point during the quarter when the yield on the 10 year Treasury note reached as low as 0.54%. The Barclays Aggregate Bond index returned 0.6% for the quarter, led by corporate bonds, which were up 1.5%.
The number one question clients are asking is “what impact will the election have on my portfolio?” Unfortunately, as was seen in 2016, the early market response to election results is as unpredictable as the election itself. Additionally, there is not much that either side has put forth that is quantifiable in terms of its impact on investment markets. There are, however, a couple of things to which we can look. First, we can look to Biden’s corporate tax proposal, which would increase the corporate income tax rate and potentially create a minimum corporate tax for companies with profits of greater than $100 million. It is estimated that these tax increases would reduce earnings on the S&P 500 by about 7%.
Further, according to research from the Tax Foundation, a nonpartisan but generally anti-tax think tank, the combined tax plan put forth by the Biden campaign would reduce total employment by 517,000 jobs. While no one should be excited about anything that reduces employment at this stage in the recovery, some context may be helpful. If we subtract that number of jobs from where the labor market was in February 2020, that puts the employment level back to where it was in September 2019 when the unemployment rate was 3.5%.
Given the fact that there are still segments of the U.S. economy that are under extreme pressure as a result of the pandemic, it is likely that either candidate will put forth some level of additional fiscal stimulus. Federal Reserve Chair Jay Powell has strongly advocated for additional fiscal stimulus publicly. Unfortunately, we do not know the particulars or timeline for a plan from either candidate.
As of this writing the United States is yet to pass further fiscal stimulus. This is perhaps predictable, but certainly disappointing. While the vast majority of lawmakers agree some additional stimulus is necessary, disagreements over the magnitude and allocation of that stimulus has left us at an impasse with many Americans left in a bind. In terms of the impact of fiscal stimulus on further recovery, it is clear that increased unemployment assistance and direct transfers to Americans, which actually brought real personal income to above pre-pandemic levels, was a key driver in kick-starting the recovery.
Charles Schwab’s Chief Investment Strategist Liz Ann Sonders recently pointed out that, “The economy impacts elections more than elections impact the economy.” This is a view that we can get behind. Historically, a recession occurring in an election year has been extremely difficult for an incumbent president to overcome. On the other hand, years in which the stock market has increased between July 31 and October 31 are generally very good for incumbents. The big caveat is that in the three elections when this has not held true, there have been significant geopolitical issues (the Suez Crisis in ’56, the Vietnam War in ’68, and the Iranian hostage crisis in ’80).
That said, we are holding a bit of cash at the moment for most of our risk profiles as a result of two factors. First, things are shaping up such that there is a reasonable probability of no further fiscal relief between now and January 2021. This could pose a significant obstacle for markets since direct transfers to workers have meaningfully contributed to the economic and market recovery. Second, the opportunity cost of holding cash versus high quality fixed income is quite low in the current environment. Given the significant amount of investor capital on the sidelines, any buying opportunity between now and the end of the year may be brief.
Much is made of the stock market returns under various configurations of the political parties that control the presidency and legislature. History shows that while there are differences, the magnitude of the difference is generally small. Further, as with all market returns, there is a dispersion of returns among these data. So, to circle back to Liz Ann Sonders’s point, the economy impacts elections more than elections impact the economy.
Increased cash levels in client portfolios have generally been sourced from the sale of short term investment grade corporate bonds, which have done well since they were purchased earlier in the year. In addition to this rotation, we have also moved some exposure away from U.S. equity index investments into more cyclical and value-oriented equity to take advantage of anticipated continued cyclical recovery over the next several years.
We understand that investors have questions around the upcoming election, the continued spread of Covid-19, and elevated unemployment, among other things. As always, we are available to discuss your portfolio and the appropriate level of risk to achieve and maintain financial independence.
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