Welcome back, and we are pleased to highlight another strong quarter of returns for the capital markets. Equities delivered positive results with US large-cap and emerging-market stocks being the standouts. Credit markets also added to the gains tally from last quarter, especially in the high-yield space. And even sovereign bonds registered positive results in the face of a more risk-on tone for the markets. The comeback in the equity markets since the lows attained this spring has been remarkable.
While it took over 2,000 days for global equities to regain their prior peak following the global financial crisis, it only took roughly one-tenth of the time to retrace the losses inflicted by the coronavirus. The market’s strong move upward has been aided by better economic data, improving news on the pandemic and some economies reopening.
The key elements underlying this healing have been the three pillars of recovery that we have discussed throughout the pandemic: the first being our efforts to flatten the viral curve; the second, to support the victims of social distancing from our largely shut down economies; and, lastly, to reopen up capital markets and liquidity.
While these efforts have had a material degree of success and the US Federal Reserve Bank has been clear in its intentions to do all they can, some cracks in the first two pillars remain. With the recent uptick in COVID-19 cases in the US and parts of Europe, it’s clear we are not entirely out of harm’s way yet. And there’s disagreement over the level and substance of additional fiscal stimulus among key governmental leaders. That’s unfortunate because we believe there’s still a lot of fiscal support needed to get economies back on firmer footing.
Which again leads us to the critical question of whether the fiscal and monetary bridge being built will be long and strong enough to effectively get us to the other side of the virus’ impact.
Our view is this will ultimately occur, but we acknowledge that challenges persist. Plus, we have a pivotal election on the horizon.
The reliance on fiscal policy makes the upcoming 2020 US election important. Passing fiscal stimulus earlier in the crisis was easier, but this process has become harder as opposing parties have become entrenched and divided.
The two split-party scenarios worry us the most because gridlock usually makes it more difficult to pass legislation.
Conversely, in either scenario of a full sweep of the White House and Senate, we would expect the momentum to pass needed stimulus measures would be enhanced, given party unity.
One by-product of the equity market’s recovery, especially in key US large-cap indices, has been the high degree of concentration driven by a narrow group of stocks. In fact, the concentration level in the S&P 500 Index from its top 10 largest stocks hit a new high of nearly 30% in August.
While it is not entirely surprising many of these stocks attained such size in the index, given the economic success that they’ve achieved, we view a degree of diversification as prudent, especially if investors expand their search to other less-traveled areas of the market.
Regardless of where investors seek future opportunities, our view is that a quality approach is now appropriate. Specifically, the attributes we deem most critical are companies that have enduring profitability, strong balance sheets and the ability to generate high levels of free cash flow.
And the good news? You can find such stocks within both the value and growth styles. One path that lends itself to finding quality companies is through a thematic approach, focusing on sustainable trends. Fast-growing areas such as digital payments and the usage of electric vehicles are expected to be rewarding and they are not highly reliant on economic growth.
Another effective way to find quality companies is to seek those with persistent earnings growth. Companies that are capable of growing earnings by at least 10% over a five-year period are extremely rare. But those that do typically deliver strong returns.
Another area that should not be overlooked is smaller-cap stocks. History has shown that this asset class has done well in recoveries and has meaningfully outperformed their large-cap counterparts in periods of economic recovery.
Also, stocks outside the US provide another opportunity that is less crowded. Over the last 10 calendar years, 75% of the world’s top 50 performing stocks have been domiciled outside the US. And that’s an average. Some years, the percentage has been in the 90s! Having a discerning lens in this, and all equity markets, is a sound approach.
And there are sound measures investors can take within fixed income. In a low-interest-rate environment, finding compelling yields to meet income or other needs can be a challenge. But select opportunities remain and are best found utilizing a multi-sector approach beyond owning only sovereign bonds. Adding certain credit sectors as a complement to government bonds is our best advice to participate and defend in the fixed-income markets.
Well, this has certainly been an exciting quarter in an already historic year and our timeless advice remains—be global, be selective and be active. Thanks so much. Please stay healthy and we will talk soon.
Capital Markets Outlook: 4Q:2020
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