Wall Street endured its worst week since March. The Dow Jones Industrial Average finished the week down a whopping 6.5% to close at 26,505.28. The S&P 500 lost 5.6% on the week to end at 3,270.17. The NASDAQ ended the week at 10,911.59, down 5.5%.
With the recent volatility, we were active with call writing in late September into early October as the market was rallying back from the early September stumble. In addition, we’ve been holding some excess cash to help smooth out some of the heightened volatility that could result from a contested election. Now that the market has pulled back, the last of our October call options expired on Friday. It’s still possible the market surprises us on election night and, after last week’s sell off, we might see a big upside move (a la 2016). Being uncovered under that scenario will allow us to maximize our upside capture and enhance our total return.
Most elections are binary events with only slightly better than 50/50 propositions. Successful portfolio management is based largely on rules and sound fundamentals. 50/50 odds isn’t a scenario even traders should place bets on. Thus, we’ll let the election play out, maintain complete flexibility, and react accordingly.
So, here’s where we stand:
- We’re holding a little excess cash to smooth volatility.
- Binary event – only slightly better than 50/50 – not great odds to bet, not even for speculators.
- Volatility cuts both ways…..downside last week, it could just as easily be to the upside this week.
- We’re maintaining flexibility to react to any outcome.
We’ve always lived by the creed that smooth seas don’t make great sailors. You have to be aware of wind changes. It’s the wind that changes, not the ocean, nor the vessel or its captain. Strong head winds are the reason for choppy waters and the experienced sailor will batten the sails to fight the turbulent conditions.
First, let’s address the two conditions that caused this tempestuous wind shift, and has created the headwinds:
- A surge in COVID-19 new cases – a new record daily average throughout the U.S, surpassing 90,000 cases. Hospitalizations are up 5% or more in thirty-six Sates. This is not an isolated national issue, but part of a global surge which is unraveling economies as the colder weather season gains momentum. (Source: John Hopkins)
- Congress recessed without reaching a compromise on a stimulus package, both sides claiming they will provide a larger package after the election process is completed. The last quoted spread remains at 2.8 trillion (Reps) vs. $3.2 trillion (Dems). Keep in mind the swearing in for the next term is not until January 20, 2021 – putting (at best) a March bill passage regardless of tomorrow’s outcome.
The first was anticipated by our scientists, who did warn us of a “second wave” coming after the hot summer months. From its beginning we were somewhat handicapped by our limited knowledge and resources to combat the new virus and mankind’s lesser degree of control over the works of “mother nature.” We’d be naive to think that what we’re seeing in Europe won’t happen to us here at home.
The second may turn out to be a self-inflicted wound in a toxic divisive political environment, and now left up to the electorate to decide who might lead us going forward. As always, we stay away from political discussions, but not from the economic forces that drive our markets.
Let’s start the economic discourse by stating our premise. We have back-tracked on the Dow Jones and broader S&P and NASDAQ indices to a mid-July trading range. Due mostly to COVID-19 and the cold weather, there is not much out there, in the short horizon, to give us a positive outlook going into year-end. We start reckoning with the reality that a vaccine is not anticipated before December (at best) and subsequent distribution to the public by the second quarter of 2021 (also at best). The obvious conclusion is that we have to do whatever is possible to mitigate the economic recovery pace slowdown as a consequence of the fiscal stimulus delay.
What became our first line of defense against economic uncertainty, as we know now, was the Fed. They took the initiative enacting a vast array of monetary support programs. But, from the outset, stipulated more fiscal stimulus would be needed to sustain a “moderate” recovery pace. While the recovery pace nuance is evident, it is not a corollary assumption that the Fed is “done,” and they have no arrows left in their quiver to offset a possible Q4:20 slowdown. With no meeting in October, the Fed’s meeting, fortuitously scheduled for this week (right after the election) becomes relevant. Their discussions will certainly address the need to accelerate those programs approved as relief for medium-sized corporations and affected industry sectors. Now more than ever, the Fed’s commitment to do “whatever it takes” becomes a rallying point. Remember, don’t fight the Fed!
Our second line of defense against economic adversity manifested itself immediately after the beginning of the crisis, in our resilient private sector. Clearly the low wage earner and small businesses will bear the bigger pain of a delayed fiscal stimulus package. We anticipate states may be impaired in extending jobless benefits, and too many small businesses will be permanently shut-down as PPP monies dry out. However, our “stronger balance sheet” industries remain productive. At the same time, the consumer has remained engaged and is not to be counted out. The economic data for September and October showed growth in Durable Goods Orders and the Housing industry in reaping the benefits of positive build-out numbers. Consumer Confidence for October at 101.3 gives us conviction in our resoluteness to overcome the present headwinds.
If we go back to “market basics,” we must keep in mind markets discount future cash-flows. The sell-off last week is a reckoning with the reality that the pandemic is not under control, and we may experience a slower recovery pace than previously anticipated. We alluded to the fact the COVID surge is global. Germany, France, U,K., Russia among others are resorting back to curtailing businesses’ hours of operation and encouraging stay home policies where “hot spots” develop. We will find ourselves refocusing on stronger social distance and face-mask measures as we confront the reality the virus remains in our midst. But we also have learned and gained faith in our development of more effective therapeutic drugs and have maintained a steadier recuperation curve on treatment. The war may not over, but victory remains in sight and within reach.
Our first reading of Q3:2020 GDP came in better-than-expected at a 33.1% increase, topping the forecasted 32%. No matter how you slice it, this represents hard evidence of our economic resiliency. The pessimists will start coming out of the woods prognosticating a Q4 melt-down, and the optimists may claim a change from present volatility is “around the corner.” But the realists will batten down the sails and reckon a slower course out of these choppy waters. Volatility will remain and we don’t want to underscore its gravity at current levels. The reality of our present market conditions calls for caution and thorough analysis.
Yes, a slower pace of recovery is today’s reality; but, to deny the recovery to date, and succumb to fear of a meltdown is not our preferred course to overcome adversity and reach calmer waters. That was, and still is, our job. Yours is to remain committed to a rational investment philosophy, and not succumb to emotional fear. Together we will reach our safe harbor!