Before getting into a fairly high-level overview of markets as we see them, we thought it worth commenting on a few more socio-macro themes. Not only do these things matter because they affect our day-to-day lives more directly than markets, but they ultimately create the landscape in which markets function.
First, and we’ve commented on this quite a bit, the rift between the haves and have-nots is increasing at an accelerating rate. Regardless of one’s politics, it should be clear as day that people seem more uneasy, stressed, and in some cases just plain angry than was the case 1, 3, or 5 years ago. The reasons for this over and above those socio-economic related we won’t get into here as some are clear, and others less so. These emotions can be good if they lead to productive change across society, such as a rebalancing of power and opportunity. We’re optimistic on this front. However, they can also be detrimental if not channeled in a positive way. Our challenge to ourselves and all we have the good fortune to influence is to do something positive with any emotion we may be feeling as a result of current events, social injustices, or other more personal stressors that may be bearing down on us. Smile more, be kind to others, and don’t let others who are having a harder time with that affect you negatively. Meet them with a positive disposition. In addition, take small steps to influence positive change within your local community where you spot unfairness or injustice. These things can’t be legislated, but must manifest organically as principle driven norms. As much as we love what we do, life is about way more than financial markets. They are but one tool that can help us along the way.
Second, and certainly related, when it comes to thinking about what a fair, decent, and prosperous society should look like, it seems to us that more weight should be given to the longer-term health of the economy than to the level of financial market prices. We are in no way discounting the role that financial markets can play in helping to lubricate the economic gears, but when a good number of employees take a job based on stock incentives rather than salary and benefits, something’s off. When almost every evening news channel flashes a stock market update on the screen when far too many Americans are holding down two jobs to make ends meet and own little to no stock, something’s off. When our Central Bank whose role it is to maintain stable prices and to be lender of last resort in the event financial markets freeze explicitly takes policy action to increase stock, bond, and other financial asset prices enriching the relative few who own such assets and helping to foster a casino-like economy where the focus is on maximizing shareholder value in the short-term (minimizing costs such as wages and long-term investment), stock options (not available to all thus contributing to the wealth gap), and accumulating debt (to aid short-term profits or extend existing maturing debt), we’ve lost our way.
This market-centric culture and everything that perpetuates it is exactly the sort of thing that drives a wedge between different factions of society. A strong and prosperous economy doesn’t need constantly rising asset prices. Financial markets that function smoothly, at reasonable interest rates are crucial, but beyond making sure they are open and free, there should be virtually no effort made to control the direction of markets. The focus needs to swing back to our economy, the people within it, and making sure employees and customers are placed above shareholders. That’s not to say investors aren’t important, but by default, they will be served just fine if the focus is placed on the workplace and customers. It’s when management and society as a whole take action with short-term profits in mind that the Rube Goldburg machine of wealth inequality gets put into motion. Short-termism is the enemy of a fair, balanced, and sustainable system. Anyone taking overt action to manipulate financial asset prices higher is part of the problem we’re facing today with respect to wealth inequality. This benefits those who have assets and leaves the rest behind.
The truth is, with asset prices where they are now, the ability for new investors who don’t yet have much wealth to make money in stocks over the medium to long term is terrible. The excessive focus on markets over the years has created a bit of a situation where we’ve borrowed growth from the future in order to keep the economy chugging via the use of extreme levels of debt and the unwillingness to allow bloated, inefficient companies to fail. The result of this is extreme market valuations coupled with a sclerotic economy that lacks the ability for fresh, robust growth going forward – an extremely problematic combination over the coming 10-20 years. We can get upset about this or we can focus on those things that are within our control – educating others on what most likely lies ahead, the risks associated with it, and structuring our lives and portfolios in anticipation of it. I think we can all agree that we’d like our children to have decent investment opportunities. More importantly, we’d like them to have secure employment opportunities. These two go hand in hand. If we focus on the latter, they’ll get the former.
That said, hopefully there will always be financial markets, because not only do we love them, but they are a tool that can be used to facilitate economic growth and prosperity. With that in mind, here’s a concise bullet-pointed list of what we’ve observed in September:
- Stocks have corrected more than -6% in September, wiping out all gains from August, per the S&P 500. Volatility has also picked up in the process. This bears watching since it has corresponded with terrible market breadth coupled with extreme investor sentiment. In other words, the summer rally has been losing steam with respect to the number of stocks that were still going up and investors haven’t seemed to notice. This is characteristic of market turning points, which could imply more downside to come in the short term.
- Also, in September, gold is down ~-5%, mining shares down ~-9%, and longer dated treasury bonds are up ~+1.5%. So far, correlations have been very high across most asset classes in September limiting the benefits of diversification. As we saw in March, during those periods of time where this occurs, it’s important to differentiate the assets that have a high probability of moving lower for longer from those that should be down more temporarily.
- To this end, given our outlook that economic growth is likely to continue slowing over the next quarter or two, we continue to favor the asset classes that tend to perform best in a slow growth environment – mainly U.S. government bonds and precious metals.
- The question still remains whether we’ll see inflationary or deflationary impulses over the coming months. The falling U.S. Dollar coming into September was fostering price increases around most commodities (inflation), but so far in September the dollar has risen; somewhat dramatically in the last week or so. If this trend continues, we could see continued pressure on commodity prices and thus a more deflationary impulse. The good news is that U.S. Government bonds and precious metals tend to do well regardless. It’s the rest of the commodity suite along with energy that would prefer a bit of inflation. At this point, it seems a risky juncture to take on more broad commodity exposure until we have a better read on which way the inflation needle will move.
- There’s good reason to believe that with the election coming up, volatility across all asset classes will likely move higher. It’s important to expect this and make sure you’re in the asset classes that have the best chance of either positive volatility or short-lived bouts of volatility. Again, U.S. Treasuries and precious metals seem better prepared in this respect. We have an expression that any investment worth owning today comes with volatility. The inverse of this of course is that those not worth owning either come with none or more. As we discussed last month in “How to Play With Fire”, some volatility is not only unavoidable, but good.
- The divergence between what stocks and other financial markets are experiencing right now and the economic and social reality is vast. As we’ve written about, we’re setting records in this respect and as a result, we should expect anything across financial markets. Our expectation is that stock markets “catch down” to those underpinning realities over the coming months with the bounce over the summer months being nothing more than a giant mega-cap driven bear market rally. Take the biggest companies out of the mix and stocks are not at all-time highs. They are lower than they were two years ago. This broad downtrend could well continue and based on math, history, and economic gravity, should be expected. That said, crazy can always get a little crazier. Markets could go up further in the short term. We should expect this too. Our positioning in the portfolios we manage for our clients takes both of these possibilities into account.
There’s never been a more important time to pay attention. From a personal economic standpoint, our financial future could well depend on it. As we pointed out in the first segment, losing half of one’s portfolio can be impossible to fully recover from. On this point, our focus every day is to do our best to make sure our clients are one step ahead of what’s coming and not being led over the same ledge as most other investors – in most cases through no fault of their own.
But it’s also crucially important to make sure we’re paying attention to what’s going on outside of our portfolios. What’s happening in my community? How am I feeling? How am I treating others? These are the real issues of the day and how we can all have the biggest impact on the world we live in. If we all collectively do better to be better, to ourselves and those around us, we win. As Ben Hunt from Epsilon Theory talks about, we can start small, within our local communities, where the “pack” takes care of itself – a bottom-up approach as opposed to the top-down political approach we all tend to assume will fix things. Interesting concept. Even more interesting to think about how the vibe out there today would change if every person within every community across the country focused on empathizing with their neighbor or their neighbor’s neighbor. Think globally, but act locally. There’s no risk in this. Talk about return on investment.
Editors Note: This article was originally published in the October 2020 edition of our “Cadence Clips” newsletter.
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