Dow Jones and Coronavirus Stimulus Bill Market Outlook: Commentary from Bel Air Investment Advisors
Q4 2020 hedge fund letters, conferences and more
Dow Jones Hits Record Highs And Congress Passes $1.9 Trillion Stimulus Bill
The Dow Jones recently hit a record high, surpassing 32,000 for the first time, and Congress passed the $1.9 trillion stimulus bill. With this in mind, I wanted to offer you insights into the market and economic conditions from Bel Air Investment Advisors, an investment firm that focuses on overseeing and managing over $8 billion in assets for 300 high-net-worth families, individuals and foundations.
Below are commentaries from Bel Air’s portfolio and research managers and next generation advisors.
Faster Vaccine Rollout Is Excellent News For The Economy
Kevin Philip, Managing Director
- “As has been part of my consistent forecast, the vaccine rollout is happening faster in the US than most had feared; this is excellent news for the economy.”
- “The continued fiscal support from the Biden Administration and Congress is going to further enhance the recovery underway.”
- “Consumer savings, recovering jobs, continued monetary support, all coupled with severe pent-up demand bode favorably for the economic outlook.”
- “Despite all of the above favorable news, there are still plenty of skeptics, nay-sayers, debt-warner’s, and forecasters of inflation horror to come – all, in my opinion, excellent contrarian indications that we are not topping out at a peak but have more growth and appreciation to come.”
- “Interest rates may very well climb higher but will still be relatively low historically – and if they climb too high, the Fed could target their monthly bond purchases exclusively on the long end.”
- “We are coming out of a tremendously traumatic year that exposed us to a global health crisis, an economic threat rivaling the Great Depression, a political environment where either side felt the end was near, and unfathomable changes to our daily social interactions. There is no doubt the ramifications of all of this are yet to be understood; we are quite reasonably suffering from collective PTSD. But I believe that the darkness will recede further and further as Winter gives way to Spring, and by Summer, we may find ourselves taking a communal (yes – in person) sigh of relief as we realize a shared confidence in renewed health and economic security. And then, at some point in the future, we will find something new to be concerned about, and I hope it pales in comparison to this past year.”
Fears About Re-Opening And Fiscal Stimulus Leading To Higher Inflation
Carl Ludwigson, Director of Manager Research
Duration Buckets
- “Investors often divide their portfolios into equity and fixed income buckets, recognizing that they need both offense and defense to balance risk. This division can lead to siloed thinking regarding each bucket, particularly when it comes to interest rates. This note will shed light on how to think about interest rate risk (a.k.a. duration) and economic risk (recently synonymous with Covid risk) across fixed income and equities.”
- “Many worry that economic re-opening and fiscal stimulus will lead to higher inflation and higher interest rates which would negatively impact their fixed income holdings in the near term. They are concerned that their fixed income bucket will have a negative return unless they keep duration very short to limit interest rate risk. This may turn out to be true, but it ignores the role of fixed income as an offset to equity risk in case the economic recovery does not occur as expected. As we saw in March of 2020, duration in the form of high-quality bonds played a key role in offsetting a potential equity downturn.”
- “On the equity side, duration is often overlooked. Yet, a common refrain in the equity market is that valuations are supported by low rates. So, what if low rates move higher? Equity valuations would no longer have this support and price/earnings multiples should contract. This would likely impact highly valued growth stocks the most because their valuation is based on projected cash flows long in the future, similar to a long duration bond. On the other hand, more cyclical value sectors such as Financials tend to thrive in a steepening rate environment. Value stocks are also historically cheap versus growth stocks, creating an opportunity to invest in the post-Covid economic recovery at a relatively reasonable price.”
Rising Rates
- “The yield on the 10-year US Treasury is up from approximately 0.9% to 1.6% year to date. While the level of interest rates is still very low historically, it is the change in rates that most impacts equity valuations. This helps explain why the equity market is starting to pay greater attention to the bond market. The massive outperformance of growth stocks versus value stocks in 2020 was, in part, due to the collapse in rates. As the yields on Treasuries rise, we should expect a reversal of this trend – with cyclical value stocks outperforming after an extraordinary period of underperformance.”
Rebalancing
- “Most investors are overweight growth stocks given the strong outperformance of this group over the last decade. In order to account for the potential rise in rates back to pre-Covid levels, consider balancing growth and value exposure in equities. We recognize that buying cyclical value stocks exposes portfolios to more economic risk, which is a reason to maintain some duration on the fixed income side. We see an advantage in adding 10-year Treasuries to portfolios given they are more liquid, effectively free of default risk, and provide similar yield on a tax adjusted basis to high-quality municipal bonds. Complementing municipal portfolios with 10-year Treasuries reduces economic risk by adding to our duration exposure. Remember, duration is a risk in the fixed income bucket, but duration is defensive in the context of the overall portfolio because it works to offset economic risk in the equity bucket.”
- “Our base case remains constructive on the equity market broadly with effective vaccines, accommodative monetary policy and fiscal stimulus supporting risk assets. However, the factor tilts within equity allocations should be balanced to manage the risk of underperformance as the economy re-opens. At the same time, we can better hedge the risk of our equity exposure with a mix of Treasuries and high-quality municipals.”
- “Finally, we recognize the potential tax impediment to portfolio rebalancing after a long bull market, particularly in growth stocks. However, it is important to note that the Biden tax plan includes an increase in long-term capital gains to 39.6% for those with income exceeding $1 million, which if it gains traction on Capitol Hill may create an incentive to rebalance sooner than later.”
Majority Of US Population To Get Vaccinated By Summer
Craig Brothers, Senior Portfolio Manager & Co-Head, Fixed Income
Covid-19 Vaccinations
- “Covid-19 hospitalizations are down 72% from the January 6th peak. One percent of the US adult population is receiving a vaccination every day. Twenty percent of the US adult population has been given at least one vaccination. The majority of the US population will be fully vaccinated by this Summer, which will promote robust spending.”
Commodity Inflation
- “The Bloomberg Commodity Index is up 45% since last year. The Bloomberg Agriculture Index is up 54% YOY. Copper prices have doubled since last March, and Oil prices have surged the most YTD since 1974.”
Fiscal Stimulus
- “The US has passed a record $5 trillion in fiscal stimulus over the past 12 months (25% of GDP). The latest package promises $850 million in direct aid to US households. Census Bureau estimates show that the majority of households are using their stimulus checks to add to savings or pay down credit card debt.”
Household Balance Sheets
- “Household wealth was up 10% in 2020 (up 5.6% in the 4th quarter alone). Consumers used the record low mortgage rates to cash out refi $152 billion in home equity (highest since 2007).”
US Treasury Market
- “The 30-year Treasury has the worst YTD total return in 100 years. The Treasury Market is pricing in higher commodity prices, record fiscal stimulus, and a vaccinated economy that is primed to reopen in the next few months. The pent-up desire by US Consumers to do what they do best (consume) will be evident in the blockbuster 2nd and 3rd quarter GDP numbers. CPI inflation will sail over the Fed’s 2% target. The Fed will be very uncomfortable if long Treasury rates move up another 50 bp.”
