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2020-Q3 Asset Management Perspective

August 10, 2020

This newsletter is the inaugural edition of something new that we wanted to start. With the evolution of our services that we have shared with you in previous correspondence, we feel that it is important to communicate regularly to reinforce our philosophies and the practical application thereof. As to how that applies here, we are creating this newsletter as a quarterly reminder of our perspective on investing and the investing environment in the near term. So, without further ado, let’s begin.

Our Three-Point Investment Philosophy

  • We invest so that potential returns can complement our own labor over the long-term.
  • Prudence in the short-term is the best way to gain benefits in the long-term.
  • Our role as advisors is two-fold:
    • Long-term: assist in defining a vision and executing strategies.
    • Short-term: assist in defining and executing prudence.

Four-Point Near-Term Outlook

NOTE: All information used in the production of this newsletter can be found in JP Morgan’s Guide to the Markets, unless otherwise cited, and is available upon request.

Color-coded perspective key:

  • Green: Positive
  • Yellow-Green: Cautiously positive
  • Yellow: Cautious
  • Orange: Cautiously negative
  • Red: Negative

Since the bear market associated with the Great Depression, there have been four macro environment characteristics associated with bear markets:

  • Recession
  • Commodity Spike
  • Aggressive Federal Reserve
  • Extreme Stock Valuations

With that being the case, those are the four characteristics that we will evaluate to gain perspective on the investing environment in the short-term.


It should come as no surprise to read that the US economy entered a recession during the first half of this year. As of 6/30/20, the decline in real GDP that defines the current recession was -12.8%–this is second only to the decline in real GDP during the Great Depression, since the time of the Great Depression. The primary driver of this recession was obviously the near uniform response of government at various levels to restrict economic activity in an attempt to stop the spread of Covid-19. The areas of the economy that were primarily impacted by government efforts were hotels and tourism, airlines and cruises, entertainment, restaurants and bars, and retail ex-food and beverage. Collectively, those industries only represent 19% of US GDP, 20% of US employment, and 7% of S&P 500 operating earnings, but restricting entire segments of the economy, regardless of size, can certainly have a ripple effect—that has been the case, as seen with unemployment peaking around 15%. As restrictions have started to ease, though, some of the negative economic consequences have begun to subside—unemployment, just as it rose very quickly to its peak, has dropped to 13.3%. Note: the very latest numbers indicate that unemployment has fallen even further to 11.1% (Source).

There are two questions that must be answered to determine if signs of economic recovery are sustainable. The first regards whether restrictions that have been put in-place will continue to be rolled back, paused, or redoubled. The key here is obviously that government is in control of this lever, and at all levels the restrictions seem to reflect the prevalence of Covid-19 cases—i.e., fewer cases mean fewer restrictions and more cases mean more restrictions. The second question concerns whether the reasonable fundamentals that were in place prior to the pandemic are able to take hold once again. Before the pandemic, unemployment was well below its 50-year average, hiring was increasing and layoffs were steady, corporate profits were strong and projected to remain so, global manufacturing momentum and inflation were respectable, and we closed out 2019 with real GDP growth of 2.1% (Source). Currently, unemployment is improving and corporate profits are projected to grow. We will have to wait and see how the rest of the data adds up.

Commodity Spike

Fuel prices are a barometer for commodity prices that we are all familiar with, and no doubt that you have appreciated the relief of lower prices at the pump just like we have. What we all have experienced at the pump reflects the broader experience of commodities. The Bloomberg Commodity Index reflects that commodities are at the very low end of their 10-year averages. One notable exception to this pattern is gold—it is on the high end of its 10-year average.

Aggressive Federal Reserve

Much like the frequent role that fuel prices play in our lives, interest rates are certainly an ever-present factor. The current state of interest rates is not too dissimilar to what we have been experiencing for a little over a decade, with a very substantial reduction having been initiated to combat the negative consequences of economic restrictions. As you most likely know, interest rates are one tool that are used to steady the economy. In times of a slowing economy, interest rates are lowered to encourage the use of capital, and in times of an overheated economy, interest rates are raised to mitigate excesses and the consequences thereof (Source). While that is the general rule, that is actually not always the way things play out.

In the analysis of interest rates, particularly that of the 10-year Treasury, since May 1963 when the 10-year Treasury rate has been below 5% (as of 6/30/20, the 10-year Treasury rate was 0.66%), the 2-year rolling correlation with the S&P 500 has been positive. In other words, when interest rates have been raised, the S&P 500 has moved mostly in a positive direction; when interest rates have been lowered, the S&P 500 has moved mostly in a negative direction. It is when the 10-year Treasury rate is above 5% that this correlation inverts—i.e., performance of the S&P 500 is opposite of changes in the 10-year Treasury rate.

The explanation for this could quite possibly be found in the prevalence of debt and the use of interest-bearing accounts. For instance, current consumer balance sheets reflect the fact that Americans hold $127.4 trillion in assets, but only $16.6 trillion in debt. It would stand to reason that when confidence in the economy and market-driven assets wanes, as it does during economic and market downturns, households would look to reduce debt and move funds from market-driven investments to more stable, interest-bearing varieties. So, assuming that is the case, increases in interest rates in that scenario would be more like placing a foot on the economic gas pedal, as opposed to the brake.

Extreme Stock Valuations

Since the Great Depression, there was only one other bull market (October 1990-March 2000) that was more magnitudinous than the bull market that ended with the beginning of the bear market in March of this year—in terms of duration, no bull market has been longer since the Great Depression. These factors led to the call of many to say that the markets were over-valued and that we were over-due for a correction or bear market (Source). While S&P 500 valuations were certainly greater than their 25-year average (18.8x earnings), they were still within one standard deviation of that average. Ironically, while valuations certainly plummeted with the bear market, the subsequent rebound has brought about valuations that are substantially greater than those prior to the bear market and are well outside one standard deviation of their 25-year average (21.72x earnings). Since 1995, 5-year annualized returns of the S&P 500 have been near 0%, if not negative, when valuations have been along the lines of the current magnitude.


It might be obvious, but based on the four factors discussed above, the outlook for the investing environment in the near-term is a very mixed bag. While we have experienced a recession, the economy is certainly not operating under normal conditions and the forecast for those conditions is as uncertain as the data, not to mention the opinions of that data. Commodity prices and interest rates would not seem to be in a place to represent a threat to the markets, at least in terms of their historical impact, but valuations are signaling to us that caution would be prudent.