Mid Year Temperature Check for Today
We continue to get mixed news on the market, the economy and the pandemic. Growth stocks are hitting new highs. The US economy is bouncing off the bottom. The pandemic is under control in Massachusetts and out of control in Arizona, Florida, and Texas. What are investor options as we head into the second half of the year?
Focus on growth
Growth stocks are the clear winners and leaders during the pandemic. They fell quickly in February, rebounded quickly a month later, and are now at new highs for the year. Yes, they are expensive when measured by standard means. They are also growing at well above average rates in terms of revenue and in their ability to continuously innovate. Investing in growth is an investment in the future. We can access growth through market cap weighted index funds, through targeted thematic ETFs and through individual positions. The actual amount and method for each client varies depending on cash flow needs, expenses, timeline and available resources.
The US economy is setting records on the downside in GDP and employment. We fully expect negative numbers to continue for some time. The letter shape of the economic recovery becomes less relevant with time. The V-shaped recovery sounds great, but can it be sustained? The W-shaped recovery sounds more reasonable, with regular ups and downs. Then there is the K-shaped return, where there are clear winners and losers. Regardless of your opinion of how we can make up the lost ground it’s clear that high unemployment will continue for years. With a lot of luck, perhaps GDP growth will be high and the overall size of the economy will hit a new record in 2021. If that happens, growth investors will be rewarded. Even if a record GDP is deferred, investors who own a piece of the innovation economy are better protected financially than those without it.
Most professionals are expecting more market volatility as we head into the election season, and for good reason. H-1B visas are under attack even though they are crucial to the long term success and growth of our innovation and technology focused economy. Continued visa issues could have significant long term implications if not resolved by the end of this year.
We often give too much credit to politicians. They have less control over the markets and the economy than the media would suggest. Regardless of who is elected, we will probably see higher taxation in order to pay our country’s bills. The Democrats would almost certainly bring in more regulation, which generally restricts growth. Either way, the question remains, “have markets already priced in election uncertainty?”. You can track how much people are paying for volatility protection in the future by looking at the vix futures curve, which today shows a spike around October. The clear message is that the market expects prices to fall around October. Keep in mind that an expectation of a drop in prices often means the exact opposite will happen as markets like to climb the wall of worry.
In the US we seem to have large areas like New York and Boston under control with rural areas showing alarming numbers of outbreaks. That makes sense since it is easier to manage public health when there are a lot of people together and it is progressively harder as population density goes to a tiny fraction.
No doubt a vaccine will be invented and widely available for free. It will be years however before Covid-19 becomes just like the flu – annual shot, no mask, and immediate treatment for everyone. It looks like there will be many vaccines, just as there are for the flu. More frequent shots to combat a rapidly changing virus can also be expected. Making a profit on Covid-19 will be discouraged for some time. But some growth companies will find a way to make a lot of money on Covid-19 prevention, treatment and containment.
The effect of free money
There is endless debate over the consequences of even more Federal Reserve bond buying and US government spending. Both seem to be rising with no clear end in sight. Both seem to be rewriting the ways markets work. As someone pointed out years ago, “there is nothing so permanent as a temporary government program”. We thought spending and support was huge in 2008 but the current actions dwarf those in the past. Universal basic income (UBI) and modern monetary theory (MMT) seem to be underway. So far there is no sign interest rates will go up in the next five years or that inflation will return. Deflation seems to be the bigger threat as the US is the only large economy without negative interest rates.
Destruction first, deployment next
Creative destruction is a well known process that drives down cost while driving up productivity. Technology is the best example of creative destruction. It is deflationary for the economy as a whole and enormously profitable. The next stage of deployment through technology may lead to much lower prices for healthcare and education. On the other hand, your monitor may have 20 new expensive tech providers and cause you to spend more money to be productive. This would be slightly inflationary in a good way. It would mean higher prices and much higher productivity.
The second half
Starting with those who want absolute certainty of return, the short term Treasury market is the only investment that can be considered a true guarantee. Right above that are certain fixed income funds with a long history of stable returns, although their prices dipped briefly earlier this year. After that are select corporate and municipal high yield bonds – actively managed bond funds are looking more attractive with each passing quarter. We are now getting into equity territory, where opportunities present themselves in the form of dividend growing stocks, high-yield credit supported by the Fed, US growth stocks, certain Non-US equity, and themes that range from recovery stocks to the leading edge of innovation. The investing environment has changed radically since the beginning of the year and investors are wise to adjust their portfolios accordingly.