Principled and Disciplined Investing
February began with stocks recovering from their worst weekly loss since October and markets in a frenzy over video game retailer GameStop, a company that is quickly becoming obsolete, similarly to video and record stores years ago.
The battle between a group of amateur investors and Wall Street professionals dominated the news and drowned out many important issues weighing on the markets, including the virus, vaccine rollouts, and likely fiscal stimulus for the economy under a new Congress and President. What happened last week is a reminder that stock price fluctuations are difficult to predict in the short-term and that the next market movers are frequently brought on by unknown events not covered by the media or predicted by investors. Given that we do not speculate in equities for our clients, we are not exposed to heavily-shorted companies that were involved in the recent events, such as GameStop. Certainly, it merits paying attention to whether or not these events have the potential to impact other financial instruments or regulations of short selling moving forward. It is always more complicated than people think, and simply not allowing short selling is not the solution as it actually helps markets operate more efficiently. At this time, there is no evidence of immediate concerns for our clients and investors not speculating in markets.
Please read on to understand our outlook and perspective on the economy and the markets. As always, we appreciated your business and trust. My team and I are always available to discuss your portfolio, provide financial advice, and address all of your questions and concerns.
The economy continues to recover from the recession, but much is dependent on the course of the virus and success of the vaccine rollout
Monetary and fiscal policies set by the Federal Reserve and Congress are significantly impacting the economy and markets to help ensure we avoid another financial crisis
The risk of inflation is not currently a cause for concern but is an important metric that we continue to monitor as economies reopen
Principled and disciplined investing with appropriate asset allocation is as important as ever and should not be changed during periods of market volatility
Our job is to help you navigate this period of uncertainty, and we continue to watch risks in all of the portfolios we manage.
A Year Later
It has been just over a year since the coronavirus emerged, bringing about the largest health and economic crisis in recent history. The economy is still trying to recover from the recession, and a sustained recovery is still dependent on the trajectory of the vaccines and keeping the virus under control. Investors believe markets have been pricing in a substantial recovery in the post-pandemic economy later this year or early 2022. While there has been much improvement in the economy since the pandemic began, millions remain out of work, with many jobs lost permanently. Any setbacks in the virus or unexpected policy decisions could lead to pullbacks in markets, especially given the bull market cycle we have experienced recently.
No surprise, 2020 represented one of the most volatile periods in U.S. stock market history. We saw the fastest 30-day drop in equity markets in the first quarter, followed by one of the swiftest recoveries, ending the year with double-digit returns in any capitalization-weighted indexes in high growth and high valuation stocks. Similarly, fixed income rose after significant fluctuations in March. During much of the year, we voiced concerns about just a handful of companies dominating the rally and driving indexes higher reminiscent of the dot-com era bubble. More recently, we have seen far more market breadth in the markets, which has rewarded investors focused on valuations. This is good news, and we expect this trend to continue, including sectors of the economy that may benefit from a new administration.
Monetary and Fiscal Policies Support the Market
The Federal Reserve works to promote a strong U.S. economy, and they are doing everything in their power to make sure that the current health care crisis does not become a financial crisis. As such, the Fed, along with other central banks around the world, has taken on aggressive, unprecedented monetary policy to provide significant support to risk assets of all kinds. The Fed’s indication that stimulative monetary policy will continue for some time is only further forcing investors into risk assets. These policies go well beyond low short-term interest rates. The Fed has a commitment to pumping money into the banking system via massive bond purchases and a target of re-inflating the economy to their goal of 2%. Further, there is a goal to reduce the unemployment rate, which still stands nearly double where it was before the pandemic hit. The Federal Reserve has also frequently referenced the need for significant continued fiscal stimulus. We should expect that President Biden and the new Congress will pass another package in the near future.
The unprecedented monetary and fiscal policies cause many to worry about currency devaluation and inflation, similar to what we saw many decades ago. Thus far, this has not been an issue for numerous reasons. While investors were paying attention to the GameStop frenzy last week, it was easy to miss Federal Reserve chair Jerome Powell discussing inflationary concerns after last week’s Fed meeting. Inflation is a risk that can sneak up on Wall Street, with many investors concerned that once economies fully reopen, we could see inflation. The concern is that this may lead the Fed to start tapering its market purchases unexpectedly and raise short term rates, causing another shock to the markets. Inflation has been well below the Fed’s 2% goal for much of the last decade, and Powell is urging investors not to react to small upticks in prices as economic activity returns to normal. Powell noted that we are “far away” from the kind of inflation experienced in the 1970s/early 1980s and that some inflation would be welcomed. The Fed will tolerate higher levels as employment rises and we return to normal, and Powell pledged that the market would get plenty of guidance before any tapering happens.
The monetary and fiscal stimulus that has fueled the markets has resulted in elevated asset valuations, including fixed income. It remains critical to understand that a great company is not necessarily a great investment if the price has no relation to its valuation. Investors often lose sight of this when they read of new disruptive technologies or health care innovations. It is easy to become emotionally attached to a stock or sector and lose track of the company's actual valuations. We continue to pay close attention to valuations and work diligently to broadly diversify client portfolios beyond growth stocks, which we certainly own for our clients. In this light, over the past several months, we have increased asset classes in many portfolios that may benefit during the economic recovery, such as small and mid-cap stocks that have responded well in the short-term. While we have held lower cash holdings in favor of equities or fixed income, we continue to be defensive in fixed income as rising long-term rates can negatively influence these securities similarly to equities. Furthermore, we are careful not to take unnecessary risks on funds invested for your short-term withdrawal needs.
In a week that volatility was also fueled by trading activity in certain heavily-shorted stock; it's an even bigger reminder that our investing principles should not change during market volatility. We must continue to rely on our asset allocation and diversification disciplines that match our time horizon, risk tolerance, and portfolio needs. Our job is to help you navigate this period of uncertainty, and we continue to watch risks in all of the portfolios we manage. More than anything else, capital growth beyond inflation and wealth preservation remain critical to long-term portfolio success.