COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q3 2020 - A Tale of Two Cities
2020 brought volatility to markets that has not been witnessed in a decade. The recession we entered in February and likely exited this June, was one of the shortest and deepest on record. August achieved multiple new all-time highs for major U.S. indices and September gave way to the fastest 10% correction in the technology heavy NASDAQ, which occurred in only three trading sessions. Despite this extreme volatility, the market remains resilient with positive returns for the year. The S&P 500 returned +8.93% for the quarter and is higher by +5.57% YTD. The NASDAQ enjoyed a robust quarterly gain of +11.23% and is higher by +25.40% YTD. These results seem surprising given the wide disconnect that exists between main street and Wall Street.
On the economic front, the employment data released for the quarter was better than expected with an unemployment rate of 8.4% compared to the 13.3% experienced in the second quarter, but a look under the hood reveals a mixed picture. The U.S. has now recovered roughly 50% of its pandemic job losses, however, that still leaves us with 11.5 million fewer jobs than six months ago before the pandemic. Regaining these jobs will be a sluggish process as most of them were in the entertainment, restaurant, retail, and transport industries. A breath of relief comes from the strength of the U.S. consumer, as they are in a significantly better financial position than the 2008-2009 financial crisis when looking at household leverage. However, without additional stimulus measures, the real economy will take longer to heal compared to the market's swift recovery. Investors are gearing up for third quarter earnings season which unofficially opens the week of October 13th. Analysts are forecasting a year-over-year decline of -21.8%, but the key question remains how long it will take for corporate America to regain their lost earnings power. At the current pace of earnings recovery, pre-pandemic earnings levels could be reached by Q3 2021. This is encouraging but we have a long way to go.
At September's Federal Reserve Committee meeting, the Federal Reserve announced that interest rates will remain near zero through 2023 and the Committee adopted a new framework for inflation to deliberately push inflation above their 2% target. The Federal Reserve will no longer use interest rate increases to head off inflation before it hits their goal. They will allow the economy to run hotter than usual to make sure their inflation targets are met. Inflation does not present itself as a near-term risk as there is too much slack in the labor market and it will take a while for the economy to get back to operating at full capacity. Until then, the shortfall will restrain consumer price and wage inflation.
Investors often worry about the bond market in times of inflation. Historically, low to moderate inflation has been good for returns in fixed income with credit exposure which is exactly the environment we currently face. The U.S. treasury yield curve continues to stay within a tight range with short-term yields anchored to the Federal Reserve's zero interest rate policy. The 10-year treasury ended the quarter at 0.68%, right where it ended the second quarter. Demand remains strong and the Federal Reserve remains heavily involved in open market purchases to keep rates low. Both corporate investment grade and high-yield spreads continue to tighten leaving little room for future appreciation and new bond issuance has set records this year. Foreign bonds are higher by +3.41% for the year, while the Barclays Aggregate Bond Index is higher by +6.79% for the year.
The third quarter has been more than a U.S story, with the weakening of the U.S. dollar, less political uncertainty and compelling valuations abroad vs. the U.S. Our international strategies are beginning to benefit. The MSCI ACWI ex US index returned +6.36% for the quarter and the MSCI EAFE index returned +4.88% for the quarter, but both remain negative for the YTD period.
THOUGHTS ON ASSET ALLOCATION
During the quarter our Investment Committee did not make any manager or allocation adjustments. Our slightly higher growth posture within our equity model yielded positive results. The growth and value disparity is the widest we have seen in years and there is no sign of the gap closing in the short-term. That could change if the economy begins to show signs of a much broader recovery. We have begun active discussions regarding positioning and rebalancing for the new year and will look to make changes in our December meeting as we turn the calendar to 2021. With elections getting closer, we continue to advise our clients on the need to take a long-term approach to their portfolio that acts in concert with a well thought out financial plan. Departing from a long-term asset allocation based on unpredictable election outcomes has historically been an ill-advised recommendation.
Regardless of the market environment, our best-in-breed managers focus on high quality fundamentals and downside protection. All our equity and fixed income managers had positive returns in the third quarter. Listed below is a subset of our equity and fixed income managers that performed exceptionally well versus their stated benchmarks.
*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios.
For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214 or Michael Unger, Investment Officer, at 786-292-0310