Monthly Market Update- October 2020September 30, 2020
After two strong months, global stock markets suffered a sharp decline during September. Internal inconsistencies abound. We share our thoughts here.
‘Volatility’ is correctly defined as a deviation from an expected result, with no regard to the direction of that deviation. But on Wall Street, particularly during bull markets and most particularly at their late stages – when all investors have come to regard higher markets as their divine right - the word ‘volatility’ becomes a polite euphemism for ‘down’. In September, by that definition, volatility most certainly returned. At the worst intra-day moment on September 24, a fully diversified equity portfolio had declined more than 10% on the month, fully erasing the strong gains of July and August. A solid month-end rally re-reversed some of those declines but still left that portfolio down nearly 4%.
Volatility Index rose less than 1% during September
That said, one of the mathematical ironies for September is that the market’s own volatility index – the VIX – rose less than 1% during September. It hovers at just over the earliest stages of the newly-COVID-driven market selloff in late February. Given all that’s happened and that might happen in the next 6 weeks, this truly can seem to defy rational expectations. But since it is based on precisely measured market-based prices and indicators, it cannot be ignored and must indeed be considered as ‘the truth,’ and this itself has implications for potential future market direction. More below.
Fluctuation of stocks in September
Likewise, no level of study of the stock market’s internals leads to any satisfying intellectual conclusion about market action in September. Which is a fancy way of saying, frankly, that stocks ‘yinged and yanged’ without any real purpose. The ‘stay-at-home’ cadre, which most certainly includes the mega-mega cap FANMAG tech stocks, got seriously winged, as did the banks, regarded as the quintessential antithesis of stay-at-home. I have written before about two other major indexes associated with economic recovery, Transports and U.S. Small Caps. These had been joined at the hip in terms of percentage returns for literally a full year but since late August have diverged massively, more than 10%. Even within Transports, the divergences have been striking. Its stay-at-home proxies FedEx and UPS surged. The rails did fine. But the truckers faltered. Of course, the airlines remain deeply in the penalty box.
No conclusions can be drawn from a study across asset classes. Interest rates across all forms and fashions of taxable and tax-exempt bonds remained in the tightest of ranges, even as stocks dropped briefly into that 10%-down correction territory. Even the commodity complex, normally the hard-wagging tail on the aggregate markets’ dog, moved only 3% on the downside, even as the value of the U.S. dollar had its strongest month since early spring, up more than 2%.*
Direction of the dollar?
Let me amplify a moment about the direction of the dollar, since in my opinion, it’s the one macro factor that made the most sense to me in September. Major currencies trade relative to each other so if, for instance, the dollar is rising, it’s pretty much a sure bet that most (if not all) other major currencies (yen, pound sterling, euro, Swiss franc, China’s yuan) are trading lower. The currency market is the largest of all, dwarfing the fixed income, stock and then finally the commodity markets in terms of daily activity.
Since it’s so large, any move of such significance must have the two major oars rowing together, price momentum and a fundamental back-story that first generates and then justifies that momentum. Again, since currencies trade relative, that back-story can only be that the U.S. in September came to be regarded as a better, in this case read ‘safer’, place to move capital toward.
Two factors stand out in my mind –
The near-term trend of Covid cases which seem to be rising faster globally versus domestically, and
The Federal Reserve’s continued avowal to do whatever it takes to keep the financial system and markets fully functional, even if they have to buy bonds (and gulp, maybe later, even stocks) to do so.
That said, explainable doesn’t necessarily make it sustainable. Just as relative dollar weakness from April thru August reversed into dollar strength in September, it can certainly re-reverse in October if one of those two factors undergoes a major re-evaluation. Neither are likely in my opinion but I can certainly be proven wrong.
Drop in market volatility vs. the significant strength in the dollar
As we were often asked in secondary school and college, let’s ‘compare and contrast’ the implications of the huge drop in measured market volatility along with this significant strength in the dollar. I’ll certainly concede this is arguable but it’s the way I see it. The former implies that the stock, bond and commodity markets are growing more and more complacent, saying essentially that all might not be great but it’s more than okay and it’s going to get better. Those aforementioned yings and yangs are traders being traders, trying to grab an extra nickel or two on the occasional ripples of a generally smooth surface. But the move in the dollar very possibly implies something more significant might lie ahead. Not that it will, but that it might.
What could get thrown into the mix?
If broad markets, even at their slightly lower levels at September month-end, are pricing in ‘okay and getting better’, any potential proverbial monkey wrenches that can get thrown into that thesis can be problematic, at least for the near term. A stock market at a still-very elevated price/earnings valuation leaves little margin for error. We can all cherry-pick our own wrenches of course – a COVID resurgence, a failed further fiscal response and a slowdown in the economic recovery would be my top three. None of these even need to actually happen, they just have to be ‘re-worried’ about.
What about politics?
Okay, a brief sortie into politics. Note that I don’t include it in my top three. Nor would I include it in my top ten, even though this is by far the highest profile issue on Wall Street. It dominates every mainstream and financial news stream and that’s not going away until (please, please) November 3. Current polls and electoral betting markets have Vice-President Biden solidly ahead, along with the considerable chance of a fully unified Congress under the Democratic flag. It’s been this way for months and last night’s debate debauchery most certainly didn’t change that trajectory, and perhaps even accelerated it. As I wrote a couple months ago, if the markets were afraid of a 2020 blue wave, they wouldn’t have rallied so strongly during most of the summer. If indeed things remain ‘as is’ thru the election, there will be no surprise on Wall Street.
K shaped recovery
I have my other issues. This ‘K-shaped’ recovery that significantly benefits the upper income/wealth folks at the expense of those not so financially well-off just screams to me that this recession, if we can even call it that, so far has done nothing to re-boot our economy, never mind the stock market. Measures of insider selling, very legal and fully disclosed sales of stocks made by corporate insiders, have soared lately.** Corporate stock and bond issuance has exploded, taking advantage of the massive supply of new liquidity the Federal Reserve has created even though the actual economy could care less. My biggest concern of all, the continuance of basically zero risk-free rates of interest, is the prevention of true ‘price discovery’ at all levels of markets and economic activity. How can anything be truly valued if the single most important macro factor implies a range of zero to infinity!!
Best to remain cautious
We remain cautious, still maintaining equity positions in client portfolios at below target-weight. But that said, the Fed’s aforementioned determination to do that ‘whatever it takes’ keeps us from being overly bearish. We did make a small venture into gold on the primary basis that if either stocks or bonds, or even both, have any kind of further risk-off come-uppance, a lot of that cash will have to flow somewhere. Though gold’s correlations with all asset classes are often very transient, it strikes us as a more-likely-than-not beneficiary of risk-off. As I write this, we’re fractionally below-water on the position. As with every portfolio position, this is under constant evaluation to either add to, or even perhaps eliminate.
The next scheduled Update would normally hit your in-box on Friday, October 30, the last business day of the month. However, it is quite possible that I will defer it until later the following week, purely because of the election. Just because I don’t see it as market-moving now doesn’t mean it won’t be 34 days hence.
Please join me and my colleague Peri Aptaker on Tuesday, October 6, at 11AM EDT for our “2020 – Guiding you Through the Markets during Troubled Times” webinar. We will also discuss potential post-election tax changes and tax planning strategies. Register HERE.
*Back in the golden-olden days of yore, like maybe 20 years ago, currency movements of even 1% would be stupefying. No longer.
**To paraphrase Alan Abelson of Barrons who once wrote many years ago – the reasons for corporate insiders to sell are varied…. but expecting higher prices any time soon is absolutely not one of them.