Election Outcome 2020: Already Playing the Hand We Have Been Dealt
- Going into the election, we have trimmed some risk.
- We are maintaining our preference for US growth stocks.
- With so many uncertainties, we recognize the importance of staying flexible.
Often, when we think about the word outcome, it can evoke a sense of an end or finale of sorts. While Election Day 2020 has finally arrived, we believe the tale of the markets is ongoing. As we turn the calendar from November 3rd to November 4th, we mark the end of a chapter in an even longer story, but it is not the end of the story. Regardless of the voting results on Election Day 2020, we are seeing fundamental economic drivers unfolding that could be positive for equity markets ahead. Citizens and businesses are starting to understand how to ‘live with’ COVID-19 and economic activity is slowly returning to normal.
- We believe there is an economic recovery underway as indices tracking activity in both manufacturing and services are trending higher.
- Consumer activity is rebounding as evidenced in confidence data, consumer net worth, and retail sales.
- Housing trends are back to pre-pandemic levels and builder sentiment is at an all-time high.
- Corporate earnings are rebounding faster than expected and forward guidance is becoming more encouraging than discouraging.
Rather than waiting to see who will reside at 1600 Pennsylvania Avenue on Inauguration Day, we have continued to rely on our process to determine portfolio positioning throughout 2020. In our opinion, equities remain the most attractive asset class for growth over the long term and our portfolios are positioned accordingly. However, over the past three months Riverfront has been trimming some equity risk in the face of new all-time highs in the US market, and what we perceive to be a volatile post-election period. The chart below summarizes the changes we have made at the asset class levels over the past three months in our balanced strategies. These actions have been a combination of risk management decisions as well as fine tuning selection with the addition of more individual equities.
We favor equities over fixed income:
We acknowledge that US equity valuations are elevated, but we believe these valuations can stay elevated given the lack of alternatives. Given the starting point for yields and spreads, we believe equities offer the best prospects for growth over the long term.
We prefer US over international:
International equities – both developed and emerging – offer relatively more attractive valuations when compared to US equities, in our view. However, we recognize that the US economy was the strongest in the world ahead of the pandemic, and current economic data trends suggest it is also the strongest developed region as we emerge from the downturn.
We have a higher degree of confidence in quality and growth over cyclicality and value:
Throughout 2020, there have been brief periods of rotation away from growth and towards value. Generally, these periods were brought on by hopes of a vaccine or therapeutic for COVID-19 and the prospect for additional government stimulus. As COVID-19 cases have begun to increase and stimulus talks appear indefinitely stalled, a lasting rotation has failed to materialize. While we have slightly increased our exposures to value and cyclicality in the longer horizon strategies over the past few months, we are unlikely to materially increase these allocations until we get a better sense the economic recovery is on solid footing.
US sector preferences:
- We remain overweight technology with an emphasis on software and services owing to our belief that the growth cycle for these companies has accelerated as society gravitates to greater use of technology to facilitate working from home.
- We also favor areas within consumer discretionary that are COVID-19 recovery plays and beneficiaries of stimulus, such as home improvement and multi-channel (physical and virtual) retail.
- Within industrials, we have bumped up exposure to sub-industries that play into infrastructure spending as either a Democratic or Republican Administration will likely embark on high levels of infrastructure spending in order to support our economy.
- Within health care, we favor medical devices over large cap pharmaceuticals due to potential drug-price legislation.
We have a barbell approach to fixed income positioning:
Our primary exposures within fixed income at this juncture include shorter-to-intermediate investment grade corporate bonds. Additionally, we hold longer-term US Treasuries to act as a buffer against equity volatility. In our longer horizon strategies, we have added exposure to ‘fallen angels’ (bonds that have recently been downgraded below investment grade) as we believe the combination of monetary and fiscal support could be viewed as backstops for companies that fall under this category.
Tactical Risk Management:
Even though the S&P 500 is roughly 8% below its September 2nd record high the primary trend as defined by the 200-day moving average is still rising. In our opinion, the pullback over the past three weeks has taken the S&P down to what we would consider a minimum retracement of its rally from March’s bear market low. So far, we believe this is a relatively mild pullback in the context of a bull market. As can be seen in the chart (right), S&P 500 levels (blue line) we are watching include support around 3240 (September’s low) and then 3050. We would wait for a decisive break of these levels before becoming more cautious.
Perhaps the starkest lesson learned in 2020 is more a reminder – always be ready for the unexpected and adjust portfolio positioning when our process suggests it is necessary. We believe the risk management component of our investment process enables us to navigate through uncertain periods seeking to reduce and remove the weight of emotions. From a technical perspective our team has identified price levels that would trigger risk management. Additionally, there are a host of fundamental factors such as, prolonged election uncertainty, an unexpected downturn in corporate earnings, or weakening in economic data; that could also lead to a course correction.
With so many uncertainties, we recognize the importance of staying flexible over the next few months.