Newspaper with "Investments" headline, and "Where to invest your money?" subheading October 8, 2020

TCM 3rd Quarter 2020 Market Outlook and Strategy Update

Newspaper with "Investments" headline, and "Where to invest your money?" subheading

Stephen M. Mills, CIMA® Managing Partner, PIM Portfolio Manager

Brad Bays, CIMA® Partner, PIM Portfolio Manager

Highlights: Despite near term economic challenges, the U.S. economy continues to rebound from its second quarter recession. A number of vaccines are currently under development by major drug companies and could be ready for use by year-end. The U.S. government and Federal Reserve have implemented powerful fiscal and monetary measures in support of the economy. We remain optimistic that our economy and financial markets will continue to recover from the effects of the Covid-19 pandemic.

Our nation is under a great deal of stress as we deal with the Covid-19 pandemic, social unrest, election year political tensions, and economic challenges. These areas of stress are causing uncertainty and even fear about the future of our country in our view. We see the social and economic fabric of our nation being tested. Confidence has eroded in our leaders and violence has erupted in many cities across the country with some groups even calling for defunding police forces. The political environment is nothing short of toxic in Washington, strangling efforts to address many important issues facing our nation. It doesn’t help that we are in the middle of a presential election year where heightened political rhetoric is causing even more divisiveness. Add to those conditions, the death of one of the most revered Supreme Court justices in our nation’s history, Justice Ruth Bader Ginsberg, and the Republican effort to quickly appoint her replacement, and you get as divisive a political atmosphere as you can imagine.

However, it seems that stock investors have essentially shrugged off these challenges and continue putting cash to work in the stock market. Since making a bear market low on March 23 of this year after falling 35%, the S&P 500 Index has recovered all of its losses as of the date of this letter.1 Currently, the popular stock market index has a positive gain of 4% for the year as of September 30, and sits just 5% below its’ all-time high made on September 2nd.1 That all sounds good especially if you are heavily invested in big company growth stocks. However, if more of your portfolio is invested in dividend paying, value stocks your overall return may actually be negative for the year. Growth stocks, as represented by the Russell 1000 Growth Index, are up 23% while value stocks, as represented by the Russell 1000 Value Index, are down 13% as of September 30.2 That’s one of the widest performance disparities ever for these mostly large company dominated indices. The growth sector has been led by strong performance in information technology, consumer discretionary and communications services stocks while the value sector performance has been hurt largely by the performance in energy, banking, and real estate stocks. At some point, we believe we could see investors shift funds into the value sector of the market but currently money continues to flow to the market leaders.

Despite the dramatic comeback in stock prices since the end of March, there are several near-term risk factors that could cause volatility in the financial markets. First, let’s start with the election. We believe this has been one of the most controversial and contentious presidential election years ever. The division between the two major political parties has stalled talks for a new federal stimulus package and has increased the level of uncertainty on the part of investors, business people and consumers. In our view, the biggest concern for investors is the possibility of a contested presidential election and perhaps even some key Senate seats, that could delay the determination of who will be in power for the next two years. If there is a legal challenge to the presidential election results that delays the certification of the election for more than a few days and a contentious court battle ensues, we believe the stock market will fall. Stocks fell about 6% on average after the 2000 Bush-Gore presidential election, when the infamous Florida “hanging chad” controversy delayed the certification of the election until late December.1 While this possibility poses a short-term risk, we believe that once the president is determined and both houses of Congress are set for the next two years, investors and business people will be in a position to better assess future government policy initiatives that may impact the economy and financial markets. Also, we believe that regardless of who is in power and what policies might be implemented, investors and business people will adapt to whatever policy changes come out of the new administration and Congress. In addition, we see the potential for an unleashing of pent-up demand as spending decisions by both businesses and consumers that were delayed because of the election get implemented in 2021.

Secondly, the coronavirus pandemic has wreaked havoc on our nation’s economy this year. During the second quarter, we experienced the largest quarterly decline ever in employment and Gross Domestic Product (GDP) as most of the nation went into lockdown in April and May. Although most states have loosened restrictions since May and the economy has partially rebounded, there is still a high level of unemployment (7.9% according to the Bureau of Labor Statistics September employment report). As you can see in the Chart 1 below, the economy has regained about half of the jobs lost during the pandemic so we still have a long way to go to get back to pre-pandemic employment.

Chart 1

Government Stimulus

In addition to the resolution of the election and the near-term potential for a Covid-19 vaccine, another reason for our optimism about future economic growth and a favorable stock market environment for investors over the next 12 to 18 months are the measures the both the Federal Reserve (Fed) and Congress have taken to support our economy. In late March, because of the potential negative economic impact of the coronavirus, the Federal Reserve quickly moved to lower interest rates and inject a significant amount of liquidity into the financial system. As is illustrated in Chart 2 below, the Fed lowered the Fed Fund rate from 2.5% to less than .25% in March and early April and has recently committed to maintaining a low Fed Funds rate into 2023, as indicated by the FOMC estimates in the chart.

Chart 2

We believe the Feds efforts helped to stabilize the financial markets and prevented many businesses from failing early on in the crisis. In addition, the Fed recently stated that they will likely keep interest rates low and maintain a supportive monetary policy for the next two years even if inflation rises above their long-term 2% inflation target.

At about the same time of the Fed actions, Congress passed a $2 trillion government aid package that put cash in the hands of consumers and businesses to help get through the lockdown. We believe these measures, which amounted to an unprecedented amount of government stimulus for the economy, may have prevented a prolonged economic depression for our nation. We believe this stimulus will continue to support economic growth well into 2021 as there is typically a 6 to 12-month lag time before government stimulus fully impacts economic growth.

Election

One of the big questions we have been getting from clients is: How will the results of the election potentially impact the economy and stock market? The primary concern we have heard from our clients is what happens if there is “blue wave” election which has Vice-President Biden winning the presidency and the Democrats gaining control of the Senate and maintaining control of the House of Representatives. In the very short term, we believe this scenario would be a negative for stock prices. It’s difficult to say how negative but our best guess would be a 5-10% decline in the major averages once the results are determined. However, we would view such a correction as a buying opportunity because we believe regardless of who has control of the government after the election, the economy will continue to recover and improving corporate earnings will fuel stock prices higher in 2021. There will certainly be winners and losers under a Democratic controlled government. Policies that raise taxes and increase regulations on business could have a damping effect on the economy and certain sectors. However, when you look back on history, the stock market has done as well under Democratic control as it has under Republican control. The table below shows returns for the S&P 500 Index under various combinations of government control by Democrats and Republicans. Notice that stocks have done very well in a unified government situation (same party holds the presidency and controls both houses of Congress) regardless of whether a Democrat or Republican is president but has done better when there is a Republican president with an annualized gain of 12.95%. We also see very good returns under the split Congress scenarios with the best outcome when there is a Democratic president. The worst performance, with an annualized return of 5.7%, came during the years where there was a unified Congress with the Democrats controlling both houses of Congress and a Republican president. Of course, the decisions of millions of private households and businesses also have an impact on the market, and government policy is but one influence on these decisions.

Looking Ahead

While we are optimistic looking out 12 to 18 months for the economy and stock market, the next 90 days could present some near-term challenges that could cause heightened volatility in the financial markets. The possibility of a surge in Covid-19 cases during the flu season could put pressure on hospitals and push authorities to close down certain businesses and activities again. While we see this as a low risk, if such a surge occurs, it could cause some short-term volatility in stock prices. Also, any disappointment or delay in the development of a Covid-19 vaccine could influence stock investors to raise cash and move to the sidelines causing the major stock averages to decline. In addition, as we mentioned above, the election results and the possibility of a contested election could cause short-term volatility in the financial markets until the results are official. In the midst of these risk factors for the markets, we are going to have a battle over President Trump’s Supreme Court nominee, Amy Coney Barret, which will likely consume Washington over the next few weeks and possibly stalling other legislative action to support the economy.

Although these risk factors could cause economic progress to slow somewhat from the third quarter pace for the next couple of quarters, we believe the underlying fundamentals of the U.S. economy are moving in the right direction and we could be in the early stages of a multiyear expansion. We feel that once a vaccine is available to be administered on a widespread basis, both businesses and consumers will resume pre-pandemic spending patterns. There will likely be winners and losers coming out of this pandemic. We see the industries that have been hardest hit by the pandemic like travel, entertainment, lodging, and restaurants coming back once consumers feel safe to participate in those activities. Beaten down stocks in those sectors could be very good investment opportunities. Companies that have been able to adapt to the new environment and offer products and services that meet changing consumer and business desires and needs could do very well as the economy recovers. Technology is one sector we highly favor as we continue to see both businesses and consumers adopting technology solutions in order to become more efficient. For instance, we believe the work-from-home trend has been dramatically accelerated by the pandemic. Companies that offer technology solutions to enhance the ability for people to work from home could do very well over the next several years. We see opportunities in companies that are involved in e-commerce, an area that has seen tremendous growth during the pandemic as more consumers and businesses buy products on-line. Healthcare is another sector we favor for the next several years particularly with the Baby Boomer generation moving into the age category that typically requires more healthcare products and services. Bottom line: We believe the coronavirus pandemic has fundamentally changed the investment landscape presenting investors with new opportunities for growth in the equity portion of their portfolio. We are working diligently to find those opportunities.

In the meantime, we understand that times like this can make it very difficult to manage portfolios. High uncertainty and market volatility can influence investors get out of stocks and seek the safety of cash and fixed income. However, we believe the best course of action right now is to stick with long-term objectives and maintain appropriate asset allocations. While to temptation is to reduce risk assets when uncertainty and volatility rise, in our experience, such timing moves often detract from portfolio performance over the long-term. However, it may be prudent to realign the equity/bond/cash mix in portfolios if it has gotten out of balance according to long-term objectives and risk tolerance.

Finally, this is not the first time nor will it be the last time that we will encounter very difficult investing conditions. However, we believe that as we have seen in the past, our economy and our country will endure and adapt to our new environment and come out of it stronger than ever. It is our privilege to help you navigate through these challenging times and achieve your financial goals.

As always, we greatly appreciate the trust and confidence you place in us. Stay safe and God bless!

Your Trinity Capital Management Team

Trinity Capital Management, 821 ESE Loop 323, Suite 100, Tyler, Texas 75701. 903-747-3960. www.tcmtx.com

Footnotes

1 Thompson quote system

2 Wells Fargo Advisors Morning Outlook, October 1, 2020.

Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and separate non-bank affiliate of Wells Fargo and Company. Trinity Capital Management, LLC is separate entity from WFAFN.

The indices presented in this material are to provide you with an understanding of their historic performance and are not presented to illustrate the performance of any security. Investors cannot directly purchase any index.

The opinions expressed here reflect the judgment of the author as of the date of the report and are subject to change without notice. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.

Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.

Wells Fargo Advisors Financial Network is not a legal or tax advisor. Consult your tax advisor or accountant for more details regarding your specific circumstance.

S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock's weight in the Index proportionate to its market value.

The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

Past performance is no guarantee of future results and there is no guarantee that any forward-looking statements made in this communication will be attained.

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