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Quarterly Commentary – September 2020

The third quarter US Equity Markets continued their upward move from the March lows up until early September when we experienced an almost correction shy of the 10% required to qualify it as such.  Market volatility returned after several months of steady advances. The following are performance numbers from various popular indexes. Please remember index numbers are not individually comparable to a properly diversified portfolio. Each portfolio may include an allocation to securities similar-to these indexes in varying amounts based on your personal risk tolerance and should only be compared in that context. The S&P 500 was up 5.6% for 2020. The Dow Jones Industrial Average was down 0.9%. The Nasdaq Composite Index was up 25.4%. The Russell 2000 Index was down 8.7%. International equities as represented by the MSCI AC World Ex U.S. Index were down 5.4%. The MSCI Emerging Markets Index was down 1.1%. Fixed Income as represented by the Barclays Aggregate Bond Index ended up 6.8% for the year.

Continuing weakness in the economy is the result of certain sectors, particularly on the service side, remaining shut down or operating at reduced capacity. It is unlikely that a full rebound can occur absent a complete resumption of the service sector.  The manufacturing sector has recovered sharply and now sits 5.4% below the pre-pandemic high. The order data suggest that business investments which were a major drag on real GDP in the second quarter, will be a significant tailwind in third quarter reporting. Social distancing measures have much less of a negative effect on manufacturing which is experiencing more strength due to pent up demand and depleted inventories.  It is important to realize that even if real GDP growth in the third quarter exceeds the drop in the second quarter, the economy is still in a hole and the recovery will take some time. This does not even consider where the economy would have grown to absent of the Pandemic.  Things are headed in the right direction, however there will continue to be disparities between sectors as well as geographical areas where varying degrees of shutdowns and re-openings are occurring.  The course of recovery will continue to depend on COVID-19, the advent of vaccines and therapies as well as public policy.  The U.S. consumer, with the help of cash deposits from the Treasury has played an important part in the recovery.  Retail sales have recovered from the lockdown declines and seasonally adjusted sales are up 1.5% from the prior January record; a new high in just five months.  The housing sector is on fire.  New Home Sales have skyrocketed to their highest levels since the financial crisis while monthly supply has declined to its lowest levels in decades.

From a long-term perspective, we are still in a bull market.  The flaw of perceiving the S&P 500 index as representative of the U.S. Equity Market has never been more evident with the largest 5 companies accounting for 24% of the index and that percentage having continued to increase over time.   These largest stocks (Apple, Microsoft, Amazon, Facebook, and Google) year to date as of 9/8/20 have produced a return of 37% while the bottom 495 companies have returned -4%.  This can be a negative when things are this lopsided.  The Tech sector has seen its weighting in the index increase to levels not seen since the Dot Com bubble and this can make things more vulnerable to painful corrections for the index.  We did see a mild correction in the Tech sector in September, which was a good thing in that it reduced some of the pressure that had built up during its 80% sustained move from the bottom.  Low interest rates and liquidity will continue to provide a floor for this market.

Earlier this year, there were concerns about complacency from the investors as stimulus money kept finding its way into stocks.  As it stands now, there seems to be more skepticism and lower confidence levels which is good

from a risk standpoint.  Mutual fund and ETF are reflecting outflows from domestic equities. Corporate earnings, although down relative to prior COVID levels, have more than exceeded analyst expectations with the percentage of companies topping analyst estimates at record highs. The flip side is when expectations are raised too high, it becomes harder to continue to live up to those expectations and selling can occur despite the good news.  The equity markets hate uncertainty and we are dealing with some fair share of it.  Although markets tend to fare well in election years, the contentious nature of the upcoming election and the expected surge in mail-in voting could make it where a Presidential winner may not be known on election night.  Markets will not like it, and this is a risk that is being priced in the post-election volatility futures markets.  Any correction based on this, should be short lived and present a buying opportunity.  In the case of change in presidential leadership, any agenda that reverses some of the business-friendly policies would most likely not materialize for a couple of years given the precarious nature of our economy.

We wish you a nice fall. Thank you for the opportunity to serve you.