Global Manager Comments on Elections and Fed Balance Sheet

Striking the proper balance between risk and reward

• Elections will potentially have a significant impact on the equity & bond markets.
• The U.S. Federal Reserve’s balance sheet, along with the balance sheets of governments around the world, have expanded significantly.

As we write this piece, we are currently experiencing an environment where the stock market has become disconnected from the broader economy. Looking back to March, the S&P 500’s 35%+ decline was more rapid and deeper than anything investors have experienced in their lifetimes. Remarkably, due almost entirely to the use of historic government intervention, the recovery was almost equally as rapid and now investors are making decisions in a world where global indices are trading within striking distance of their all-time highs. It is important to note, however, the market’s recovery has been primarily concentrated in a select few large cap technology names. As a recent WSJ article points out, the technology sector now represents a 40% (45% if you include Amazon – which is technically a consumer discretionary name) weighting of the S&P 500 – an anomaly not seen since the 1930’s.

As a result of the historic intervention discussed above, coupled with years of easy monetary policy, governments (now more so than ever) and individuals are heavily indebted. As much as mass bankruptcies may not be imminent, inflation and slow growth seem to be natural extensions of this condition. To further complicate things, short-term interest rates on some government and corporate bonds have turned negative, while ten-year U.S. government bonds are paying well under 1%. As such, main street has now become reliant on interest rates staying low for the foreseeable future.

Against this backdrop, we have constructed a portfolio that we believe will perform well over the long-term. Unfortunately, short-term market movements can cause performance variances. As such, we believe it is important to look at the drivers of performance to obtain a full picture.

Contributors

• The financial sector declined just over 22% in the first nine months of 2020, driven by historical low interest rates.
• The avoidance of the real estate sector. We view real estate investment trusts (REITs) as a type of forced bond substitute. After all, it is easy to see why collecting a 3%-5% dividend yield against a leveraged stream of cash flows could make sense in our current ultra-low interest rate environment. However, the risk in this scenario is when there is a problem with a consistent collecting of those cash flows. It is at that point that share prices of REITs decline and ultimately forgoes many years of dividend payments. This sector was down 15% in the first three quarters of 2020.

Detractors

• As of the end of September, the consumer discretionary sector gained nearly 20% year-to-date. The gains in Amazon, Alibaba, and Tesla, which comprise 1/3 of this sector’s overall weightings, drove gains in the entire space.
• The information technology sector. As of the end of September, gains in Apple and Microsoft were primarily responsible for this sector’s 26.81% year-to-date gain.
• Consumer staples sector. Overweighting stocks in a defensive sector that specializes in selling goods necessary for everyday life did not fare well in a year dominated by expensive stocks simply getting more expensive. That said, lately, signs of food inflation are beginning to emerge, Campbell Soup and Bunge offer attractive dividends (yielding 2.85% and 3.60, respectively).

Risk Mitigation

In the early 1980’s, interest rates on 10-year Treasuries and money markets were hovering around 13%, while 30-year mortgage rates were north of 18%. Today the rate on a 10-year Treasury is well under 1%, money markets pay close to 0%, and 30-year fixed rate mortgages are being financed under 3%. As such, there are two major risks inherent in investing in any individual bond or bond portfolio. Duration Risk – or the amount a bond will decline when interest rates rise. And Credit Risk – or the likelihood that a given company pays its creditors.

In Closing

In a world where the COVID-19 pandemic appears to have had lasting effects on many behaviors, we believe this is a market where slow and steady wins the race. With investing, it’s all about striking the proper balance between risk and reward.

Managed Asset Portfolios’ Investment Team:

Michael Dzialo, Karen Culver, Peter Swan, John Dalton, and Zack Fellows Economic Outlook

The information contained herein does not represent a recommendation by us to buy or sell any security or securities mentioned within this presentation. Certain statements may be forward-looking statements and projections which describe our strategies, goals, outlook, expectations, or projections. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause actual results to differ materially from those expressed or implied by such forward-looking statements. Past performance is no guarantee of future results.