Client Letter 2020 Q3

Q3 2020 Market Results

After being hit very hard in the first quarter by the Coronavirus pandemic, then followed by a strong (but not complete) recovery in the second quarter, the market continued its recovery during the third quarter.  So much so that the S&P 500 hit a new all-time high in early September.  The S&P has backed off a little bit in September, but still finished the quarter up +8.93%.  International investments were up as well at +4.80% and emerging markets were up a strong +9.56%.  Bonds were up a less impressive +0.62% and short-term treasuries were up +0.10%.  Weaker bond gains mostly coincide with continued recovery in riskier assets.

Portfolio Thoughts

Portfolios did well in the third quarter.  Tactical portfolios benefitted from the adjustments to growth and value that we made, along with adjustments to high-yield bonds.  Strategic portfolios benefitted from the rebalancing we did in the first quarter.  Our momentum portfolio (AAA) continues to perform very well.  The model still suggests that U.S. investments have momentum and that continues to prove true.  There are some early indicators that the momentum may be shifting toward global investments, but not yet enough to push the model to change.  We will continue to monitor that situation and adjust all of our portfolios accordingly.  Our Capital Preservation strategy also had a very respectable quarter and continues to help very conservative clients enjoy market returns with much less market volatility.  We pulled the trigger to rebalance all portfolios during the recent September pull-back and we hope that will pay benefits when markets continue in the upward direction.

Looking ahead, we expect to see strong Gross Domestic Product (GDP) growth in the third quarter, making for a very short recession of only one quarter.  We believe the economy will continue to recover as people and businesses get more back to normal, and that should support continued gains in the stock market.  The S&P 500 is currently at 3,363 and we think a reasonable estimate for year-end should be around 3,500.  However, there are some concerns to consider.  We are in the middle of a pandemic and we don’t know if we will see a second wave.  If we do that could result in shutdowns similar to what we experienced in April.  Europe appears to be in the early stages of a second wave and the idea that it will come to the U.S. is not unreasonable.  We don’t yet have a vaccine and though there seems to be high confidence one is coming, it can’t help until it is actually available and proven safe and effective.  Plus, if/when we get a vaccine we still have to deal with how to get it to the American people.  The process of manufacturing the vaccine in ample volume and distributing to citizens will take months.  Any issues along the way have the potential to upset the markets.  Knowing this I am having some difficulty understanding how the S&P 500 hit a new all-time high in early September.  No one hopes all will go well more than me, but ignoring the potential problems seems a little too optimistic for my liking.  Given all that, our estimate of 3,500 for the S&P 500 seems reasonable, though it could be a volatile ride getting there.

Q3 2020 Notes

The third quarter hit some depressing milestones as related to the COVID-19 pandemic.  In the U.S., the world’s hardest hit country, COVID deaths broke the 200,000 barrier and global COVID deaths now exceed 1,000,000.  The economic impact is not yet fully understood and until the virus dissipates or we have herd immunity, the economic toll will only increase.  It’s hard to believe the staggering impact we have seen caused by the virus.  Here’s hoping we don’t see a second wave and a vaccine becomes available soon.

Our government came together in a very bi-partisan way in March 2020 with Congressional approval of the CARES Act and subsequent signing by the President.  The $2.2 trillion CARES Act provided needed relief to individuals and businesses affected by COVID-19.  Most economists believe the CARES Act reduced the overall economic damage, and helped encourage the recovery that began in June.  Since March, Congress has proven far-less bi-partisan and has not been able to pull together a second relief package.  The concern is that many components of the CARES Act had specific end-dates, and those benefits are now ending leaving many in a difficult position.  A second fiscal stimulus package is almost certainly needed.  I hope it happens sooner rather than later.  Speaking of the stimulus, it’s important to understand that these stimulus packages are entirely built on deficit spending, making our national debt climb at an unprecedented peacetime rate.  It’s also important to understand that the stimulus package is money being directly injected into the economy.  This is nothing like the quantitative easing used back in 2009 after the Global Financial Crisis (GFC).  That money went into bank reserves and was closely controlled as to how and when it got into the economy.  This means that today’s fiscal stimulus packages have the potential to create future inflation.  It’s not guaranteed, but we are paying close attention because investments will need to shift if inflation makes its way back into our economy.  Lastly, with respect to this deficit spending, some question the need and logic of driving such large government deficits.  They generally do not agree the spending should happen.  I don’t agree.  My feeling is that COVID-19 is a global disaster with the potential to send economies into depression.  As much as I worry about the ever-expanding national debt, this situation requires high levels of government spending to assure a successful recovery - similar to the deficit spending needed to fight a war.  In this case, a war against a virus.

The Federal Reserve (Fed) has been very active during the pandemic.  They’ve lowered interest rates and developed a number of monetary support programs to help banks and businesses.  Interestingly, the Fed announced it would allow for inflation to run above its 2% target in order to compensate for inflation that has run below the 2% target for an extended period.  I find it interesting because the Fed, try as it might, has not yet been able to push inflation to the 2% target, let alone above it.  Is it possible they see the potential for inflation (caused by stimulus spending) as I mentioned above?  Only time will tell.

I’ll take one brief moment to at least mention the fact that we have an election coming soon.  The two candidates are clearly very different.  They differ on policy and they differ in personality.  I certainly won’t endorse either candidate, but I do believe that voting is a critically important task for American citizens.  It is the one way we have some say in how our country is governed.  It’s not perfect, but better that most other options and worthy of the time it takes to cast a vote.

As always, we will watch and research the global economy and make investment choices to the best of our ability for each and every client portfolio.  If you have questions about your portfolio, our views expressed in this letter, or anything else financial, please do not hesitate to call.

Best Regards,

Jim

Barron Financial Group, LLP is a fee-only Registered Investment Advisor regulated by the Connecticut Department of Banking.

This newsletter is for general information only and should not be considered investment advice.  Investors should consult with a trained investment professional to discuss their particular situation.