The Brave Report: Market Commentary for December 2020

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Let’s party like it’s 1987… During a year of uncertainty like we have rarely seen before, the Dow Industrials just notched its best monthly performance in over 30 years. November also marked the 2nd time this year the S&P 500 gained more than 10% during a month which has only happened one other time since 1982. While November is historically the best performing month for markets during an election year, the performance we just saw was far above what anybody expected.

There were some very positive catalysts that contributed to this outperformance. Vaccine progress has given us hope of an end to the pandemic, election uncertainty has diminished, and Biden’s initial cabinet appointments seem to be much more moderate than many in the markets had feared. However, coronavirus cases, hospitalizations and deaths continue to reach new highs every day and large portions of the population are starting to be ordered back into lockdowns. As we head into year-end, I expect market performance to be primarily driven by how far into the future investors and traders are willing to look. The further out they can focus, the better the markets could perform.

Market Overview

The markets just completed a historic month with all major indices rallying more than 10%.  The Dow and the Nasdaq each returned close to 12% over the course of the month while the S&P 500 trailed slightly, notching a return of 10.9%. The performance of the US markets was amazing, however, domestically we still trailed the performance in Europe.  The European Stoxx 600 index just completed its best month in history, gaining just shy of 14%.  This widespread, global, bounce in equities illustrates that markets have looked past the election and are focusing on the prospect of an end to the pandemic.  While I agree with this optimism, I would still stress a little caution.  The markets have run pretty far pretty fast and until we get a better picture of how and when this vaccine will be distributed around the world, we still could be in for quite a bit of economic pain before the all-clear is sounded.

On the fixed-income side, we have seen rates remain relatively range-bound, especially considering all of the political and pandemic news that has come out over the past month. We saw a small spike in rates following the election, especially in the 10- and 30-year treasuries, but those rates quickly settled back down, and we find ourselves trading only slightly above where we started the month. We have definitely seen a slight steepening of the yield curve, but this is only relative to where we were earlier in the year, which was flat to inverted in some spots.  Overall, rates remain near historic lows and I expect this to continue to be the case until we can fully emerge from the pandemic.

As I already mentioned, the Dow just registered its best month since 1987. While this is an important milestone, it does not tell the whole story.  We have seen quite a bounce in the markets from their March lows, but most of that bounce was driven by technology and other growth-oriented names.  What we saw in November was a rapid increase in the breadth of positive performance.  The outperformance was market-wide and not just limited to a select few sectors.  During November, 467 of the 500 S&P stocks finished positive. This was the widest positive performance we have seen since April (when the whole market bounced off the March lows).

I have seen some pundits try to call this a rotation from growth to value but it wasn’t as much of a rotation away from one thing and into another but a catch-up in participation.  As uncertainties were taken off the table throughout the month, more economically sensitive areas of the market started to see some money flow.  This bodes well for the sustainability of the rally, but it is also important to understand what these catalysts were to see if they have staying power.

The Biden Presidency: The election has been a major overhang in the markets throughout the year. Even beyond the election, there was also a fear that no matter how the Nov 7th vote went, we would see a long-drawn-out fight in the courts to determine the winner.  While there have been some legal challenges by the Trump administration, none of them have held much merit and the margin of victory was great enough that Trump would have had to win legal battles across too many states to make it feasible. Trump will probably never admit defeat, but this has allowed us to start looking forward and understanding what a Biden presidency will really mean.

On this note, there has been a fear on the right and throughout wall street that Biden would be drawn to the progressive left as he built out his administration.  What we have seen so far is a much more moderate approach, especially in his economic appointments.  Most importantly, Biden selected Janet Yellen to be his Secretary of the Treasury.  Yellen is far more moderate than any of the other names I have seen floated and is someone that most republicans respect.  She is also not an unknown.  She was the Chair of the Federal reserve during Obama’s 2nd term.  Her appointment removes a lot of uncertainty from what Biden’s economic influence will be.  Investors don’t have to guess as to what her thinking is on the economy and the markets and that is a major positive moving forward.

Vaccine Progress: Outside of the election, the other major catalyst we saw over the past month has been the release of data from late-stage vaccine trials.  All of which have been far above expectations.  While the election outcome lit the fire of this rally, this positive trial data just added more fuel.  We now can start formulating a roadmap as to when this pandemic will be over.  This catalyst was a major contributor to the breadth of the rally as the more economically sensitive areas of the market need life to return to normal in order to fully recover.

I understand the initial euphoria around these vaccines and echo the long-term optimism for the economy and the markets.  However, I do think it is also important to stress caution in the short-term.  A vaccine is not an immediate silver bullet that will fix all the problems overnight.  It will be months until the vaccine can be rolled out to enough people to have a noticeable impact on cases.  Production limitations and rollout logistics pose a great risk to the speed at which the vaccine can have an impact.

Additionally, just as this vaccine is being rolled out and we are ramping up production, the pandemic is also ramping up.  As I write this, cases, hospitalizations, and deaths are hitting new all-time highs across the country and I only expect this to get worse as we go through the holidays and the winter. We have seen a large percentage of California, along with some other places across the country, go back into lockdowns.  This will have a major negative impact on the economy in the short term and require continued fiscal and monetary support (which congress has struggled to deliver on) to limit the long-term impacts of the next few months.

I am not trying to sound negative on this topic but just correctly set expectations for the next few months.  Markets are forward-looking and as I have discussed earlier this year, near-term economic results only represent a small portion of the value of a stock.  If the markets can maintain the recent long-term optimistic outlook as we grind through some tough months ahead then there is no reason that this rally can’t continue into next year. It is plainly important to understand that a vaccine getting approved does not mean the economy is back to normal.  There are still a lot of steps that need to happen in that process.

Strategy Commentary

I started to increase my overall equity allocation over the course of the month as part of some larger rebalancing.  With the election over and some uncertainty removed from the markets, I was comfortable adding to some of my positions.  I did not expect the markets to bounce as much or as fast as they did over the course of the month so was not able to put all the cash to work that I had wanted to.  I will wait for any weakness over the next month or two to continue to increase my equity allocation.  With the vaccine on the horizon (albeit with the actual timing still up for debate) I like the long-term outlook for the economy and the markets coming out of the pandemic.

I continued to maintain my overweight to technology.  While we have seen some other sectors play some catchup due to the vaccine news, I still think that technology will be what sustains the markets over the next 6 months.  I will be looking to add to some of the more cyclical sectors as we get some more certainty about the vaccine rollout. Energy, industrials, and financial services have all outperformed recently and if we can continue to get positive vaccine news some of these sectors may show promise as the economy opens back up.

Internationally, I missed the rally in Europe over the past month.  Europe responded more favorably to the vaccine news although only slightly and I think some of this might have just been catchup from previous underperformance. I have continued to add to some emerging markets including China.  They continue to be ahead of the rest of the world in terms of economic recovery and should give us a decent indication of how the rest of the world can perform as they move past the pandemic.

I continue to prefer larger a cash position to a full fixed income allocation.  Rates are near the high end of their trading zone since the start of the pandemic, but I expect to see rates to stay relatively low until the economy is back to normal.