It’s Crystal Ball Time – What the Next Six Months Could Look Like

Key Points

• Year to day 2020: Volatility is driving the bus.
• Three key factors will drive returns for the next six months.
• Portfolio flexibility will be the key between good, great and poor returns going forward.

I have written about the volatility index (Vix) before as well as talked about the volatility of volatility. I don’t know about you but to me, 2020 feels like it’s about three years long. The market started off the year incredibly well only to fall off a cliff in late February. Since February, there’s been significantly higher uncertainty than any of us are used to. When uncertainty is high, the daily trading range for markets and stocks is wider than normal. Great for traders, not so much for investors who like markets that trend up most of the time. I would love to say I see volatility mean reverting lower on a trending basis but with all the uncertainty we have currently, that’s hard to imagine. As you can see from the chart of the Vix Index above, the Index went vertical between late February and late March and has been falling but volatile ever since.

2020 Year-to-date: Stubbornly high volatility doesn’t want mean to revert lower.

Vol has been trading in a range between roughly 47 and 23 since mid-April. There’s simply too much uncertainty for the Vix Index to get below 20 right now so investors have to be on their toes and willing to trade the current range in markets. The good news: we are nearing some key inflection points that could decide the next direction for markets. Good or bad, more clarity allows actions to be taken. Short-term, a temporary move over the 35 level could take the Vix Index back to the former highs around 47. If this occurs, the move should be swift and then offer a significant buying opportunity for your favorite stocks. Remember: buy fear, sell euphoria.

The three key factors that will determine the next big move in stocks:

1. Election clarity
2. Vaccine clarity
3. Fiscal stimulus clarity.

Election Clarity

The market loathes uncertainty. It didn’t like the trade war rhetoric and uncertainty and it doesn’t like the election uncertainty. The election is less than a week away and even if it takes an extra week or two to get the votes counted, the election uncertainty will be removed. Market participants are already starting to front-run who the winners and losers will be depending on how the results shake out. The market may or may not like the results across the Presidency and Senate but at least we will know what the rules of the road might be. Historically, gridlock is the best outcome for markets so anything other than a Biden win with a Democrat sweep in the Senate should be viewed favorably. The market just wants clarity and its coming soon right around the corner.

Vaccine Clarity

If a large chunk of the economy is still operating at less than half its normal capacity, a vaccine is needed to shift back to a “let’s get back to normal” consumer sentiment perspective. If consumers here and abroad feel confident about a treatment and a pre-emptive vaccine, we can get back to normal quicker. It’s impossible to gauge how likely an imminent vaccine announcement is. All we know is there are many companies and governments collaborating on a solution and with that much collaboration, I find it hard to believe we won’t have something tangible by year end. As long as virus uncertainty exists and we are operating without a vaccine, the economy will stay slow, but it feels like we are not that far away from having positive clarity on this topic.

Fiscal Stimulus Clarity

I am as frustrated as everyone else that politicians are playing chicken with the lives of millions of Americans and businesses that are in desperate need for more help. It’s hard to fathom not getting a bold new stimulus bill given how much damage there is across much of America. We need an extra bridge in the form of new fiscal stimulus to get part of America to the other side of this pandemic. In my opinion, it is not a matter of if, but when and how much we get. Getting more clarity regarding the size and timing of fiscal support to individuals and businesses will be a key driver of removing uncertainty. I think a new stimulus package will be the most important driver of lower volatility, higher stocks and improving consumer sentiment. Remember, 70% of U.S. GDP is household spending so when we worry less, we tend to spend more. That drives up GDP which is directly tied to the trajectory of equities.

The key to navigating high uncertainty: Flexibility

If you wanted to cross a running river, are your odds better if you have maximum flexibility to decide the strategy or if you are forced to cross it in only in one place, at one time and with one strategy? I think most people would agree having a lot of flexibility offers better odds of success than limiting yourself. The same is true where investing in today’s market is concerned. We don’t know when the next equity market pullback will begin, how deep it will go, when it will bottom and begin rallying or which stocks will experience less drawdowns or recover quickest. All we know is being able to adapt to whatever the market throws at you is likely a better strategy than being forced to do one thing regardless if it seems prudent.

More clarity is coming. That’s good news.

Will growth keep outperforming value? Will economies that are improving quicker than the U.S. outperform our markets? If interest rates continue to rise and the yield curve continues to steepen will cyclicals start leading the market? Will this drive more flows into small-caps relative to large caps? When the economy reaches its real trough, will lower quality companies begin outperforming higher quality companies? My crystal ball is no clearer than anyone else’s but I feel confident that being able to adapt to markets and invest across a full spectrum of stocks and styles offers a better chance at outperformance than if I was forced to invest in only one or two types of stocks.

Summary:

Here are some key takeaway points for investors:

• Volatility is here to stay, and uncertainty offers wonderful trading opportunities.
• The market does not like uncertainty, but we are close to getting some important clarity.
• If investors have maximum flexibility to adapt to market gyrations, they will likely have much better odds of success.

Disclosure:
This information was produced by and the opinions expressed are those of the author as of the date of writing and are subject to change. Any research is based on the author’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however the author does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. There are no material changes to the conditions, objectives or investment strategies of the model portfolios for the period portrayed. Any sectors or allocations referenced may or may not be represented in portfolios managed by the author, and do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results.