Market Pulse – Mid Third Quarter Update

We hope you have been enjoying the summer months, spending time outside and continuing to connect with friends and loved ones.

Everyone here at TWG has been safe and healthy while continuing to balance work and family life.  Vince and Jackie have enjoyed many motorcycle rides and outdoor dinners with friends.  David is fully refreshed from a road trip around California with Kelly and their kids, enjoying the natural beauty that only California has to offer. Tara has been enjoying puzzling, physical fitness, walking her two dogs and continues to do an excellent job with the voluminous workflow. Kelly Palmeri, our newest addition, is enjoying spending time with her one-year-old son, hiking outdoors and is proving to be a quick study as our new receptionist.

As we arrive at the mid-way point of the third quarter, and wanted to update you on the overall economic backdrop, portfolio construct and what lies ahead.

MARKET PERFORMANCE

The S&P 500 turned positive on a year-to-date basis at the end of July – a truly incredible stock market recovery since the cycle low of March 23^rd.   The economy continues to improve, albeit with some lumpiness depending on what sector is evaluated.  There is renewed acceptance that with each passing day we are closer to having a viable vaccine available to aid in reducing the severity of the pandemic’s health impact around the world.

Having re-tested its 200-day moving average (MA) for the second time in late June, the S&P 500 now sits close to 10% above the 200-day MA, confirming the uptrend remains intact.  Beneath the surface, we have observed a broadening of the market, as more stocks are trading in a positive trend and more companies have erased most, if not all, of the losses incurred during the pandemic sell off. This widening of market breadth is a healthy sign that investors continue to be more confident and that the road to recovery is firmly in place.

The tech heavy NASDAQ continues to make new all-time highs, recently breaching the 11,000 level for the first time in history, and currently sits with a 22% gain for the year.  The S&P 500 is up 4% YTD and the Dow Jones Industrial Average (DOW), dominated by more industrial constituents, currently is still negative 2% YTD.  The dispersion between the various broad indices suggests that the recovery has not been equal for all components of the market.  But over the past weeks and month, we have observed the DOW catching up and advancing more rapidly than both the S&P 500 and the NASDAQ. This may suggest that the uptrend can persist even in the face of the presidential election.

KEY ECONOMIC DATA

Earnings season has reflected the negative economic impact from the national shut down. Most companies’ earnings are significantly lower than they were prior to the pandemic, and even on a year over year basis.  However, the market being a forward-looking mechanism, continues to allow a “pass” for Q2 with hopes of an earnings trough and better days ahead.  Only time will tell, but if the market has this right and we should see notable earnings improvement moving forward quarter to quarter.

The second quarter gross domestic product (GDP) reflected a substantial decline in economic activity on a year-over-year basis, contracting 9.5% compared to Q1 (32.9% annualized). This is the steepest decline in this reading since 1940 — clearly reflecting the economic strain caused by COVID-19 and the related economic slowdown in almost all corners of the economy.

The gradual weekly improvement in new jobless claims indicates that the market contraction may be temporary.  We need to see a continuation of more people returning to the workforce as business continue to cautiously re-open consumers increase their spending due to pent up demand, and corporate cost reductions help increase operational efficiencies.  Recent corporate cost cutting measures have the potential to breathe new life into their future earnings growth which can pave the way back to pre-pandemic earnings levels.

TWG PORTFOLIOS

TWG Sum-IT portfolios are positive on a YTD basis and continue to keep pace with their corresponding benchmarks.  One-year returns have effectively been normalized, reflected in performance results that are outpacing our average expected annual returns.  Another way of saying this is that by and large your portfolio, on a one-year basis, is in line with the expected long-term return assumptions for that particular risk level.

Thanks to the outsized returns from QQQ, and to a lesser extent XLG, we have kept up with the rising tide even after having a substantial cash position at the start of the recovery period.  We have been fully (or close to fully) invested for several months now, only making small allocation shifts along the way.

Given that we have observed a more enduring broadening of the market, along with the recent relative weakness in mega cap tech compared to more cyclical companies, we booked some profits from our QQQ position and re-allocated those profits to a large cap value fund, OUSA.  This fund invests in high quality companies that have been able to maintain dividend growth.  This fund gives us exposure to areas of the market that we shied away from in the earlier days of the recovery.

We believe that systematically broadening our exposure to sectors such as industrials, financials and consumer cyclicals will  smooth out the ride should the broader economic recovery maintain its footing. This will be demonstrated by continued strength in these sectors relative to the previous dominance of mega cap technology.  Should we see this trend continue, we are ready to shift even more capital from growth to value.  Should this cyclical trend become more fleeting, or even quickly reverse course, we stand ready to make the necessary adjustments to stay overweight in areas demonstrating sustained relative strength.  We are not yet ready to commit client capital to smaller companies.  Having a barbell approach with some exposure to value will allow more consistent participation in those areas of the market that continue to trend higher.

LOOKING AHEAD

Several key developments may drive the market in the months ahead.  The first, and biggest, is the upcoming presidential election.  Leading up to election season, market participants will likely attempt to position their holdings and/or hedge against several likely outcomes which may result in heightened volatility.  We are eyeing one of three likely scenarios.  First, if Trump is re-elected and Republicans keep the Senate, a status quo environment may persist as reduced concerns of potential higher regulation and higher taxes wanes.  Second, should a Democratic sweep occur, the market may anticipate higher regulation and higher taxes.  Third, a Biden win with the Republicans keeping the Senate may create a more split government which perhaps would be the most “neutral” scenario to the markets.

Also important is if the government can agree to extend the expired enhanced unemployment benefits and the additional small business relief programs. If millions of Americans cannot find work, and no longer have supplemental benefits to enable continuation of their spending, the market may become less confident of a sustained recovery.  The same is true for businesses. We are watching these areas closely

CONCLUSION:

We remain confident that the economic recovery can continue, which should help keep the market at or above current levels.  As market breadth continues to expand and more companies rebound, the market should continue to rise as we move closer to a vaccine.  Investor sentiment is not fully bullish, and there is still a significant amount of cash waiting to either enter the market or find a new home with more return potential.  TINA (There Is No Alternative) and FOMO (Fear Of Missing Out) are two themes of the current climate, and have the potential to keep the market elevated and grind higher.

As the summer days get shorter and we look toward back-to-school season, we are hopeful that the path of recovery continues.  We will be keeping a close eye on the election, and other fiscal and monetary stimulus programs that may be announced after Congress returns from recess. We stand ready and willing to both protect and grow your accounts.

We wish you well.