The summer of 2020 will be remembered by many as one of social distancing while treasuring time with family. We at Glen Eagle have adopted the timely motto of “Pray, Trust, Wait.” With the global emergence of the COVID-19 virus, we have witnessed both an economic and healthcare impact in the United States that in many ways is unparalleled. As states and local municipalities began implementing quarantine measures, the economy slowed dramatically, spurring our first recession in over a decade.
The magnitude of the slowdown has been staggering as over 40 million workers applied for unemployment, 30% of renters failed to pay a portion of their rent, 95% of air travel disappeared, and 70% of small businesses applied for financial support from the federal government (via the PPP loan program). In response, the stock market had its fastest decline in American history back in March.
What has surprised many investors, however, is the fact that this drop was immediately followed by the fastest recovery in history. In fact, the Dow Jones Industrial Average (the “Dow”) recorded a bear market that ended in just three days! While this return to growth has led many to wonder if the stock market is still based on reality, given the poor economic situation, we believe its movements can be understood when looking at two major factors:
- Stock Market Composition: 78% of the S&P500 is made up of companies in the technology, financial, healthcare, utilities, communications, consumer staples, and internet retail sectors. Some of these industries have been minimally affected or, in some-cases, have benefited from the quarantine environment (ex: “the Amazon-effect”). Conversely, close to half (45%) of all jobs in the economy come from companies in sectors such as entertainment, hospitality, retail, auto, construction, manufacturing, and energy – all of which have been negatively impacted in a major way during the past few months. With this contrast it becomes more evident how the stock market could be rising as the economy is simultaneously slowing down.
- Federal Reserve Support: The Federal Reserve responded rapidly to the economic slow-down and immediately applied the tools at its disposal to prevent the current recession from becoming what many initially thought could be a depression. In particular, the Federal Reserve brought interest rates down to near zero and provided trillions of dollars to corporations, municipalities, and even the stock market in order to create stability. These actions have had two key impacts. First, they have encouraged investors to continue buying equities since the perceived risk of doing so is lower with the seemingly infinite financial support of the Federal Reserve. Second, interest rates at near 0% mean that most fixed-income investments provide significantly lower yields. We see this in our bank savings account or in the 1-year treasury bill, which now offers less than 0.15%.
As we continue with an economy and stock market that have taken divergent paths, the question becomes what are some key themes that we, as educated investors, should pay attention to? Below we have summarized four that we think are particularly relevant in today’s environment:
- Small Companies (i.e. “Small Caps”): Many investors believe the Federal Reserve’s actions will ensure that the market does not have another major correction. As a result, stocks that previously were too risky to investors have become more attractive. In fact, small cap companies that are currently losing money have risen 32% more from March through mid-July than the small cap companies that are profitable. This poses a significant risk to investors since over the long-run stock prices follow earnings rather than the whims of investors that are buying for short-term profits.
- Banks: As we have discussed in our previous newsletters, banks tend to be significantly less profitable when interest rates are low. The recent decision by the Federal Reserve to both restrict the amount of dividend payments and temporarily ban the share buy-back programs of the large banks has made these companies less attractive to investors. As a result, investors should view bank stocks as a longer-term investment that will start to rise substantially when the path to normality is clearer.
- Real Estate: The average 30-year mortgage rate has fallen to its lowest level in over 50 years (2.98%). That will act as a boon to the real estate market as people realize they can now buy that dream home with affordable financing. Multi-family and single-family residential home REITs (publicly traded real estate companies) should benefit from this trend over the next several years, especially when unemployment begins to fall. The stock of these real estate companies will also become more attractive to investors since they typically pay a higher dividend, which is now even more enticing in this low-yield environment.
- Social Impact: As millennials have become a larger portion of the investor population, they have vocally promoted investing in companies that are deemed “socially responsible.” Even though the definition of what constitutes a socially responsible company is still often ambiguous, the amount of money in mutual funds and ETFs (Exchange Traded Funds) that claim to invest with similar priorities has continued to grow. A decade ago, these funds held $30 billion. Today they account for more than $120 billion. We expect this trend to continue which will further benefit the stock prices of companies that are deemed socially responsible. This is due in part to the fact that the largest institutional investment firms, which control 80% of all ETFs, have indicated that they will continue to prioritize these issues and, when necessary, pressure company boards to take action on specific social issues.
As a final note, during volatile stock markets it is often enticing to look at the extreme rise and fall of specific stock prices with a sense of envy or fear. It is important to avoid these emotional traps and instead review your life goals to ensure that your portfolio reflects your specific risk-tolerance and timeline. As Mark Twain wrote, “The secret of getting ahead is getting started.” If you ever have a question or would like to review your portfolio or financial plan, please do not hesitate to reach out.
Wishing you a safe and relaxing rest of the summer,
The Glen Eagle Investment Team
Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.