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ACM Journal - Investment Management
13 Jul

Portfolio Review – Q2 2020 Newsletter

The second quarter was marked by a global pandemic, a largely paralyzed global economy, racial tensions that boiled over into violence, heightened political discord, record jobless claims with 40 million people unemployed, continuing business failures, geopolitical tensions with Hong Kong largely being subsumed by China, locusts in India and Pakistan that could result in famine, and even murder hornets in the pacific northwest. So, of course, the stock market rose, posting its best quarterly performance in over 20 years.

The S&P 500 gained 20%, mid-cap and small-cap stocks did even better, and international stocks rose 15%. Returns for all major segments of the stock market are still down year-to-date, but certain industries, such as technology, are now at all-time highs.

To be fair, we were starting at a fairly low level for the second quarter. The stock market had declined quite a bit by the end of the first quarter, so a rebound off those lows wasn’t completely crazy. However, given the circumstances today, it is hard to fathom that the S&P 500 is only 7% off its high and the NASDAQ has eclipsed its previous high and is now trading 7% above where it was at its peak last February.

Government stimulus has played no small part in this. Both fiscal and monetary policy have been accommodative to say the least. PPP loans and $1,200 stimulus checks are just the tip of the iceberg. The Fed has expanded its balance sheet far beyond what we have ever seen in the past. Perhaps some or all of this was necessary to save the economy, but there is no question it is warping the stock market.

Things are not as bad as the most ebullient days of the 1990s, but there are definitely signs of speculative excess. Tesla’s share price has more than tripled so far this year and the company is now worth more than Toyota. Never mind that upstart Tesla sells a few hundred thousand cars and might be profitable this year while the 82-year-old Toyota sells over 10million vehicles annually and earns $19 billion in profits.

Stories like Tesla’s are becoming more common. Nikola is a start-up truck manufacturer that has yet to make a production version of its trucks, yet it was trading at a level that made it worth almost as much as Ford. Shares of bankrupt companies, such as Hertz and Chesapeake Energy, have traded at irrationally high levels even though the shares will ultimately be worthless.

Today’s market is hard to understand, but the future is even more cloudy. Will government stimulus measures be able to buffer the economy until COVID has passed? Will the Fed be able to withdraw liquidity as the economy recovers before inflation becomes a concern? Will the elections in November result in a transformation of our economy away from capitalism? Can today’s high stock market valuations continue? Will interest rates remain low for years to come? These are big, but unanswerable questions.

While uncertainty seems extreme today, the reality is we never know what the future holds. No one could have predicted a global pandemic and subsequent economic shut down. I saw a graph recently with the title “Reasons to Sell”. It showed the S&P 500 over many decades continuing its upward trajectory but had notes with negative events throughout history. Despite world wars, oil shocks, inflation, natural disasters, terrorism, and countless other horrors, the economy and stock market have proved resilient.

That doesn’t mean there won’t be speed bumps along the way. Our one guarantee is that the market will be volatile and at some point, portfolios will lose money. The best way to protect against that is diversification. Spreading your “bets” across various asset classes (stocks, bonds, and alternative investments) and diversifying broadly within those asset classes is the best we can do. It isn’t a panacea, but it has proven effective in the past at minimizing loss, providing liquidity when it is needed the most, and also generating long-term growth while keeping pace with inflation.

Despite the zaniness in the stock market today, we’ll continue to build diversified portfolios with long-term risk and return characteristics that give the best chance of surviving and thriving in the years to come. And, despite short-term uncertainties, a steady, long-term strategy remains your best bet for building and preserving wealth over time.

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