Risk On, Risk Off, or Risk Neutral

Earnings season began this week on Tuesday and will continue through August 9th. The peak day is Thursday, July 30th with 286 companies reporting. The next earnings season won’t be until mid-October. Due to COVID, this quarter stands out as the most opaque, non-indicative earnings season ever. Risk on, risk off is no longer an adequate description for guiding investors during a pandemic. Here are some considerations to keep in mind:

Unemployment is more than mixed

There is something for everyone to like or hate about the current unemployment numbers. There are weekly numbers, which are the most current, but are subject to astounding revisions. Monthly numbers are better, but are lagging. Then there are the six different types of unemployment, to further complicate the picture.

The flip side of unemployment is there seem to be many job openings at all levels, which should indicate that unemployment can fall quickly. No matter what your view of employment is, current claims are stubbornly high and not falling quickly. There is plenty to worry about for those who have personally been furloughed or don’t have a job. Even if they are receiving extra income through a voluntary departure or a supplementary check, it is still likely not to be enough in this environment.

Virus growing

The COVID virus is spreading quickly again in the United States. California, Texas and Florida are reversing their previous openings. The Northeast has been more successful at containing the spread, but the rest of the country has not. When it comes to the virus there is very little good news. There appear to be multiple virus strains, and high temperatures are not killing the virus. Florida reported a record number of new daily cases for the entire country. The average age of those dying from COVID has fallen. Vaccines and treatments are way in the future. The only thing that could get worse right now is if we run out of hospital beds and we are getting closer to that in some spots.

K-Shaped Recovery Confirmed

So far the recovery has been K-shaped, with significant blocks of losers and gainers. The difference between investment winners and losers is apparent when you consider that over 1000 public US companies have lost at least one third of their value in 2020. On the upside, 900 companies are at least positive for the year. We expect the bifurcated recovery to continue. Investors have the option of investing in weakened recovery stocks or the healthy growing ones. One curious result from this episode is that the business cycle of boom and bust may finally be gone, thanks to the Fed.

Diversification is under attack

It is easy to attack diversification because many areas of the global economy have struggled in recent years. In 2020 especially, the world has been forced to change to an extreme degree. Choices for future growth may have narrowed but there is still plenty of diversification available in stocks and bonds, domestic and international.

A true global market cap weighted portfolio has never been a popular choice, and for good reason. For example, it is little known or appreciated that foreign bonds are the biggest single asset class worldwide. Investors of all kinds do not want that much fixed income in their portfolios, let alone foreign fixed income.

The equal-weight versus market weight debate also continues for good reason. Equal weight has been lagging badly for the last five years. Diversification is simply a very big word in the investment world that can mean a diversified portfolio of single stocks, diversified ETF or mutual funds, diversification at the portfolio level by geographic focus, etc. Individual circumstances, experience and investment goals count the most when designing a diversified portfolio. The toughest part about diversification is staying diversified when just a handful of investments seem to be doing all of the work.

The Weeks Ahead

This earnings season gives us a taste for what is to come since it is the first quarter of business results operating under a pandemic. How far off (positively or negatively) are the general consensus forecasts? No one other than the company officers can know for sure. When we design portfolios today, we are looking for investments that can sustain a compounded growth rate for many years. Many are focusing on building resilient and defensive portfolios that are shielded from risks due to an election, a possibly overextended market and an ongoing pandemic. Once we get through this earnings season, we’ll have a much better idea of what we can expect from the coming quarters.

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