Equity markets traded mixed this week, with investors questioning current valuations and stimulus talks continuing in Washington. Both sides of the aisle took baby steps toward an agreement in recent days, but differences remain on the size and scope of the package. The economic picture is beginning to reflect the grim reality from COVID, with US jobless claims increasing significantly more than forecast and continuing claims also on the rise. Inflation also slowed more than forecast last month, indicating demand remains subdued heading into winter. With virus cases surging and healthcare systems at capacity, it appears that the next several months will present significant challenges for the economy. The question remains, is this priced into current equity prices?
Despite the warning signs, markets are proving remarkably resilient to bad news thus far. Perversely, we may be in a situation where bad prints encourages more risk taking, with investors wagering that the negative figures will push policymakers to act with both monetary stimulus and fiscal aid sooner rather than later. In Europe, the virus’ spread has already led to an increase in the European Central Bank’s bond buying program, with the announcement of an additional ~$600 billion in stimulus funds. Once again, we are reminded of the stark disconnect between financial markets and the real economy, with shutdowns and unemployment affecting the situation on the ground, but corporate America prospering. In a further nod to this bifurcation, demand for equity securities is predicted by some to outstrip supply by over a trillion dollars next year, led by wealthy retail investors, corporations, and sovereign wealth funds. While the unemployed are flat on their back and desperately waiting for aid in a situation caused by a widespread natural disaster of sorts, investors of means continue to benefit from rising profit expectations and a financial system flush with cash. Those in search of safe, lower risk returns meanwhile, face significant headwinds from potentially rising interest rates and already paltry yields on cash and fixed income securities.
As mentioned in recent weeks, we believe market exuberance may be a bit extended in the near-term, and that a healthy pullback could be warranted. Expectations for the Fed and Congress to act could lead to disappointment for investors in the short run. We remain bullish heading into next year, however, as the reopening of the economy should continue to support risk assets into 2021 and beyond. To that end, we have trimmed the overweight to equities marginally to add additional liquidity to portfolios, but remain largely pro-risk across our allocations. Particular pockets of opportunity can be found in emerging markets, small-cap stocks, and cyclicals, which we believe will rebound in the coming quarters on the back of the vaccine rollout and increasing earnings. With that in mind, any volatility should be seen as a buying opportunity in our view, with upside ahead for patient investors. As always, we continue to remain extremely focused on monitoring unfolding market dynamics and reacting only when appropriate. Please feel free to call our office with any questions you may have.