9/21/20: Today’s market action reflects investors’ frustration with Congress’s inability to pass additional stimulus. The implications surrounding Supreme Court Justice Ruth Bader Ginsberg’s death have the potential to capture the Senate’s attention. Federal Reserve Chairman Jay Powell, in a speech last week, stressed “more fiscal support is likely to be needed” to help struggling small businesses and the roughly 11 million out-of-work Americans. The “big five” tech giants – Facebook, Amazon, Apple, Microsoft and Google – have fallen 17 per cent from their recent peak reached on September 2. The broader S&P 500 is flirting with a 10 per cent correction.
We believe the current selloff is nothing more than a correction for two reasons. First is valuation. Equity markets have become victims of their own success. Relative to their 15-year history, US large-cap valuations are situated near their highest levels across the board. The only exception is relative to the 10-year Treasury yield. Bulls argue that low interest rates justify current valuation and unprecedentedly low rates warrant high valuations. Perhaps that’s true, given the current cost of risk aversion.
We also take comfort in the fact that credit conditions remain intact, despite a ratcheting down of growth expectations. Investment-grade credit spreads – the yield premium lenders require to extend loans to high-quality corporate issuers – remain well within the normal range. That was not the case in mid-March.
Even the yield differential between the most troubled companies and their high-yield counterparts remains at around median levels, suggesting abundant liquidity for both high- and low-quality companies. That’s a good sign in this market.
Perhaps we’re setting up for an upside catalyst; investor pessimism itself could be that catalyst. Looming election uncertainty combined with the potential Congress will not enact additional fiscal stimulus gives wary investors plenty of reasons to stay away from the equity market. As of last week, bullishness among members surveyed by the American Association of Individual Investors was in the bottom quintile of its historical range, suggesting widespread pessimism. Today’s market action will undoubtedly dampen their moods further. History has shown that extreme bearishness breeds bull markets. In a market that responds to the intersection of reality and expectations, it’s much better to start out with low expectations than high expectations.
We’re not suggesting that today’s market represents a remarkable entry point for long-term investors. However, we believe investors who are currently engaged in the market should keep their positions in place. The Cresset team will be recalculating our quarterly capital market assumptions at the end of this month and will be reviewing our long-term risk allocations then. Stay tuned.