12/1/20: Equity markets delivered their best monthly showing in over 30 years in November, despite the fact that COVID-19 infections are spiraling upward at their highest rate since the outbreak began. Will pandemic blowback buffet optimistic investors?
November was a remarkable month on several fronts. The 2020 presidential election recorded the largest voter turnout in our country’s history. Eighty million voters applauded President-elect Biden’s victory, while another 74 million Americans were disappointed that their votes did not win President Trump a second term in office. November also witnessed a series of announcements on vaccines, each highly effective in the fight against COVID-19. The news removed one of the biggest investment risks by putting a timeframe on lifting the lockdowns, ditching our masks and getting our lives back to normal. The markets cheered.
Investors ploughed nearly $90 billion into equity funds in response, helping propel the S&P 500 10.8 per cent, its best monthly showing since January 1987. The rally was driven by a resurgence of the “pandemic losers”. Energy stocks gained nearly 30 per cent, while financials, a distant second, experienced a 17 per cent pop. Royal Caribbean International, a poster child of a business turned upside down by COVID-19, rocketed 40 per cent. The Dow broke through 30,000 for the first time thanks to 25+ per cent gains in Boeing, Honeywell and Goldman Sachs. Global equities also applauded the anticipated end of the lockdown: Italy and Spain, two countries hit hard by the pandemic, surged more than 25 per cent on the month.
The vaccine headlines helped investors grasp a more concrete timeline for recovery. The National Academies of Sciences, Engineering and Medicine envision a four-phase vaccination rollout. Phase one, which could take place as early as this month and would comprise about 15 per cent of the population, includes health care workers, first responders and the elderly, particularly those in nursing homes, homeless shelters, prisons and long-term care facilities. Phase two includes K-12 teachers, school staff, childcare workers and those employed in public transportation and food supply; these groups comprise 30-35 per cent of the population. Phase three, covering 40-45 per cent of Americans, would include young adults, children and workers employed in hotels, banks, higher education, gyms and factories. Immunization of children will depend on safety testing. All other Americans will be covered in phase four; according to Dr. Anthony Fauci, the nation’s top infectious disease expert, they could get their first doses between April and July.
Nonetheless, significant challenges still lie ahead between now and July. Like our European trading partners, the United States is grappling with a third wave of infections. This time around more than three times the number of Americans are getting infected as they did in March and June. Virtually every state has enacted new sets of restrictions: California issued a partial stay-at-home order, prohibiting activities between 10pm and 5am; Illinois prohibits bars and restaurants from serving patrons indoors, while outdoor activities are limited to 10 people or fewer; mask wearing is recommended across the country.
The additional restrictions are pressuring small businesses and individuals at a time when many of them were already reeling. More than 10 million Americans who had jobs before the pandemic now find themselves without a paycheck. The combination of high unemployment and the expiration of safety nets point to a rise in debt defaults and business closures. Restaurants will be among the businesses hardest hit. Earlier this year, the James Beard Foundation estimated that two-thirds of America’s restaurants would not survive the fall season without direct aid. That aid never arrived.
Consumer confidence – a good harbinger of retail sales activity that plunged in response to the lockdowns – has not rebounded to the same degree that retail sales growth would suggest. Perhaps households, spending their unemployment checks, are concerned where next year’s income will come from. The job market, which displayed remarkable resilience this summer, has started to exhibit signs of strain. Initial claims for unemployment insurance rose in each of the last two weeks, exceeding their four-week average.
Perhaps lawmakers will help fill the gap. Investors cheered President-elect Biden’s cabinet choices, particularly former Federal Reserve Chairwoman Janet Yellen as Treasury Secretary. Wall Street inferred the incoming administration will be taking a moderate stance on policy. Investors also anticipate a fiscal spending package will be approved early next year, providing a needed lifeline by extending jobless benefits and small business support.
Risks remain on Main Street if anticipated policy measures don’t pan out. Banks, particularly regionals, would be vulnerable to loan defaults without adequate fiscal support. Residential mortgage delinquencies, which are running at nearly 8 per cent, are approaching a level not far from the peak reached at the height of the housing crisis. Eight per cent is alarmingly high considering Congress’s CAREs act, passed last spring, included mortgage forbearance. Mortgage forbearance is set to expire on December 31.
Notwithstanding the challenges, we believe the recent rotation into cyclicals is justified. Equity investing requires discounting the future. We see opportunities to invest in high-quality companies that didn’t participate in the summer rally. But it is important to understand the difference between value stocks and stocks trading below fair value – and that’s why individual security selection is crucial. Thanks to generously low interest rates, there has emerged a population of insolvent companies that are surviving by issuing new debt to fund operating losses and interest payments. They may look cheap on the surface, but they’re cheap for a reason and we expect them to slip into bankruptcy next year as interest rate trends reverse. In our view, high-quality cyclical companies that possess pricing power should complement a tech-heavy portfolio next year.
