September 2020 – The home stretch…

As we head into the 4th and final quarter of the year, there seems to be no abatement to the list of market risks we follow. As of Wednesday (09/23), both the Dow and S&P 500 Indices are just shy of achieving a full 10% correction from the recent highs achieved on September 2nd. While, we all like seeing higher stock prices the market dip we are seeing this month is healthy and needed.

Why would a market correction be healthy and needed you may ask? Well, as I have mentioned numerous times before market gains are not linear and given the nearly 60% gain on the S&P 500 Index since it’s low on March 24th it was time for the market to take a breather. This breather, characterized by a slight correction has flushed out a lot of the “hot” money from unsophisticated/novice investors who are trading these market, adding to volatility, have no conviction in what they purchase and have not truly experienced a market downturn. This should aid in consolidation but there are more pressing concerns that need to play out before the market can continue higher.

I have narrowed these concerns down to 3 market risks our clients are inquiring about the most and would like to address each of these below in the question and answer format.

Q: Will a “second wave” of the Covid-19 virus cause another market crash?

A: Although possible, we do not believe another market crash from a “second wave” is likely. Reason being health care providers now have a better understanding of how to treat patients with Covid-19 resulting in fewer deaths. In addition, we now have more effective protocols such as mask wearing and social distancing, various FDA approved anti-viral treatments such as Remdesivir and more effective and widely available PPE. Given the raw economic damage caused by the initial lockdown there is an extremely low tolerance for any future economic lockdowns.

Q: The uncertainty surrounding the Presidential election

A: Financial markets dislike uncertainty mainly due to a shift in economic policy. While a Biden presidency may mean a shift away from various pro-growth policies of the Trump administration, it is possible any negative market impact may be muted and short lived. Remember, economic forces tend to dominate policy and any major policy shift needs to be approved by both chambers of Congress and based upon the current information I’m reviewing it appears that both houses of Congress may remain split.

Historically, markets and the economy have shown little preference for either Republican or Democratic leadership. Yes, while there are risks associated with potentially higher taxes and increased regulation, and specific industries may experience a meaningful impact from policy shifts – there is a high possibility that it may be just business as usual.

Each presidential race (and each presidency) is unique, and the parties change over time, adapting to shifts in their constituencies and the national environment, so history may apply more or less to the current race. But, to the degree that history matters, it tells us that we probably should not put too much stock in political outcomes as a market driver. Yes, we think policies matter, but larger economic forces usually matter much more. Think back and imagine pulling out of the stock market when either former President Barack Obama or President Trump was elected because of political concerns. In hindsight, it would have been a huge mistake as markets favored both. Politics makes us passionate; it keeps us engaged -but strong political views applied to your asset allocation can interfere with sound investment decisions.

Q: Is the market over valued given the current risks?

A: Let’s talk valuation. How do we know when an individual stock, exchange traded fund or a market Index such as the S&P 500 or the Dow is attractively priced or expensive relative to their price history? In most cases (without getting into the weeds) we use valuation ratios such as Price to Earnings, Price to Book, Price to Sales and Price to Free Cash Flow. These ratios are by no means fail proof, but they give us an idea of whether a stock or an index is trading at a premium or discount to its fair value based on profitability, growth, and its balance sheet or EBITA (earnings before interest, taxes and amortization).

Currently, the S&P 500 forward price to earnings ratio is 21.94. Historically, peak levels that have marked the end of bull markets fell into the 18-19 range and the long-term average of the index is 15-16. So, at face value you could argue that the market is currently overvalued.

However, we do not think the current FP/E of 21.94 is irrational given the massive fiscal stimulus from the CARES Act in addition to the monetary stimulus and back stop of the Federal Reserve. Couple this with depressed interest rates that reduce the attractiveness of bonds (making stocks more appealing) and a vaccine being available within the next 3 months we believe the S&P 500 Index could crest 3,600 in the next 6 months. We still expect another fiscal stimulus bill to get passed eventually which would greatly aid in equity markets grinding higher.

Historically, September is the worst month of the year for equity markets and this month has been no exception. We should expect much of the same over the next two months until the election is behind us and a vaccine(s) are granted FDA approval. We’re on the home stretch and these events will play out very soon but we need to be patient.

Until then, remain diligent and strong and please reach out to us with any questions or comments you may have regarding your specific situation.

As always, please have a great Friday evening and enjoyable weekend.

Jaran Day Chief Investment Officer

Griffin Dalrymple, CFP®, Chief Strategy Officer