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Quarterly Client Report Commentary

Re: The Investment Outlook for 2020: A Midyear Review

Dear Client:

We hope this letter finds you and your family well as we all share in adjusting our lives to the Coronavirus pandemic. As you can imagine we have also been immersed in news and research related to the virus and it’s economic and market effects. Many of the research and strategy firms we utilize (Goldman Sachs, J.P. Morgan, Blackrock, Russell Investments, etc.) have been providing nearly daily reports, conference calls, and webinars. In the balance of this commentary we will try and provide some insights into what we see, and our expectations for the future.

  • Social distancing measures to combat COVID-19 have plunged the global economy into the deepest recession since the Great Depression.
  • Some success in slowing the spread of the disease and a recognition of the economic toll from social distancing are leading to a relaxation of social restrictions. However, a resumption of a normal economy will have to await the widespread distribution of a vaccine, hopefully in 2021.
  • In the U.S., following a huge GDP decline in the second quarter, we expect to see a sharp bounce in the third. However, progress from then on should be slow until a vaccine is distributed. This suggests double-digit unemployment into 2021.
  • Fiscal stimulus will support living standards through the pandemic but will add to the risk of higher inflation, higher interest rates and higher taxes within a few years.
  • While Fed easing and the recession have generally reduced Treasury rates, massive QE does threaten higher inflation and higher rates down the road. Meanwhile, the recession is leading to a wave of corporate downgrades.
  • While there are good reasons for U.S. equities to remain relatively resilient in the midst of the social distancing recession, the rebound in stocks from their March lows may be overdone, risking a correction in reaction to disappointment in economic data or medical progress.
  • Although the entire world economy has slumped into the social distancing recession in a similar way, the paths out could be quite different, and those economies with more disciplined public health practices or deeper pockets could fare better in the rebound.
  • The extraordinary events of the past few months serve as a reminder of the benefits of diversification as well as the importance of paying attention to valuations and maintaining a long-term perspective in investment strategy.     


Any analysis of the global economy and financial markets in the middle of 2020 needs to start with an understanding of the pandemic itself. As this letter goes to print, COVID-19 has killed over 400,000 people worldwide and 110,000 in the United States. The good news is that radical adoption of social distancing has caused a plateau and a decline in both the number of confirmed cases and fatalities in the United States, as is the case across most advanced economies. However, with some relaxation in social distancing, it is likely that this progress will stall, if not reverse, in the months ahead.

It is also worth noting that we are far away from “herd immunity,” which in a disease of this virulence, may not kick in until over 60% of the population is immune. Analysis of mortality data in South Korea, Taiwan, Australia and New Zealand, where the disease has been essentially wiped out through intensive testing, contact tracing and quarantining, suggests that COVID-19’s true mortality rate is close to 1%. If this is the case, and allowing for the lag between infection and mortality, less than 5% of the U.S. or global population has been infected to this point. This suggests that, while better treatments may reduce mortality, both governments and families will likely continue to practice social distancing until a vaccine is developed, manufactured and distributed, hopefully in 2021. This, in turn, implies that the global economy will continue to suffer from the effects of social distancing well into next year.


For the 1st Half of 2020 with all the market havoc and uncertainty there are only two asset classes with positive YTD returns. The Bloomberg Barclays Aggregate Bond index was up 6.1%, and Cash earned .5%. All remaining asset classes are down between -3.1% and -19.0%. Large Cap US stocks (S&P 500) are down -3.1%,  High Yield Bonds are down -4.7%, Emerging Markets Equity was down -9.7% Developed Markers Equity (EAFE) was down -11.1%, Small Cap US (Russell 2000) was down -13.0%, Real Estate Investment Trusts (NAREIT) were down -13.3%, the Bloomberg Commodity Index is down -19.4% YTD. The Asset Allocated diversified portfolio performed well as compared to most individual asset classes by declining only -4.5%. Despite the abundance of negative YTD returns the 2nd quarters returns were quite impressive to recover from the 1st quarter lows.     



 It is clear that the U.S. has fallen into its deepest recession since the Great Depression. What is less obvious is the shape that the recession is likely to take in upcoming quarters. Some argue for a V-shaped recession, some suggest a U-shaped downturn and others grimly prophesy an L-shaped depression. If, however, we recognize the current partial relaxation of social distancing behavior, acknowledge that there can be no full resumption of “life as normal” until a vaccine is distributed and finally assume that this occurs in the second quarter of 2021, then a pattern emerges. This pattern, which should be visible across real GDP, employment, profits and inflation, consists of a slump, a bump, a crawl and a surge. On real GDP, it now appears that output could fall by about 40% annualized in the second quarter following a 5% decline in the first. It should, however, bounce higher in the third quarter, perhaps rising by more than 15% at an annualized rate, as manufacturing, construction and auto and home sales move back to more normal levels. However, thereafter progress should slow. One reason for this is that there are wide swaths of the economy where it is very difficult to achieve social distancing or operate profitably with social distancing protocols in place. In particular, activity in restaurants, brick and-mortar retailing outside of groceries, air travel, hotels, sporting events and all large-group activities should remain severely depressed until a vaccine is widely distributed. The collapse in energy investment spending (due to low oil prices) and widespread state and local government layoffs will likely also weigh on economic activity in the months ahead. Consequently, we expect real economic growth to average roughly 5% annualized in late 2020 and early 2021, before accelerating to roughly 10% annualized for a few quarters once a vaccine has been distributed.


Core bonds performed well through the first half of 2020 as pervasive risk-off sentiment amidst a global recession and the reintroduction of quantitative easing (QE) domestically weighed heavily on long-term U.S. bond yields. Moreover, sharp reductions in policy rates to effectively zero and forward guidance from the Federal Reserve (Fed) should keep front-end yields near zero over the medium term. While yields have moved lower previous rounds of QE suggest—perhaps counterintuitively— that long rates tend to rise following the first few months of asset purchases and settle at a higher level even while purchases may be ongoing. There are three reasons that might explain this: 

  • Fiscal stimulus: In most instances, previous rounds of QE, similar to today, have been met with expanding budget deficits. Indeed, massive Treasury issuance to fund government spending plays a factor in the supply/demand balance within the market. 
  • Money supply: Large scale asset purchases increase the money supply, therefore increasing the risk of higher inflation. As a result, nominal yields may adjust in order to compensate for that risk. 
  • Forward guidance: Clear policy expectations set by the Fed help in supporting growth and inflation expectations, both of which are fundamental drivers of nominal bond yields.

Massive amounts of Treasury debt issuance and Fed buying could potentially lead to higher inflation as the economy recovers, pushing yields higher into 2021. Still, while yields may grind higher, uncertainties around the outlook are likely to limit just how much higher they can actually go. Therefore, we will be balanced for the remainder of the year, maintaining an allocation to high-quality duration as a hedge against equity risk, while also positioning for slightly higher yields via assets like floating-rate bonds.


Some investors were caught flat-footed by the uninterrupted bounce back in equity markets from the March 23 lows. In general, this rally is driven by three things — a slowdown in case growth, the fiscal and monetary policy response and the expectation of a V-shaped recovery in corporate profits. We acknowledge that growth has slowed and the policy response has been significant, but doubt that S&P 500 earnings per share will hit a new all-time high next year. The majority of the weakness in 2020 profits will come during the second quarter. That said, markets are inherently forward looking. While we acknowledge that earnings growth will improve in 2021, it seems like a V-shaped recovery will be difficult to achieve. Historically, it has taken about three years for earnings to reach a new all-time high following a drawdown, and the economic recovery looks set to be somewhat muted. The sectoral mix of the equity market is far different from that of the economy, but it is still important to recognize the relationship between nominal GDP and earnings. 

Many investors are questioning the sustainability of market valuations. Our research shows that a 50bp decline in the 10-year U.S. Treasury yield should add around 1x to the market multiple; with the 10-year down about 100bps from earlier this year, this helps to explain some of the increase in valuations during recent months. At the same time, however, falling earnings estimates have corresponded with a market rally, putting further upward pressure on valuations.

That said, it is important to remember that valuations are not a good short-term indicator, and stocks can get more expensive before they get cheaper. Markets seem to care much more about the direction of the data, rather than the level, and the gradual reopening of the economy seems to be commanding the majority of investors’ attention at the current juncture. However, plenty of risks still remain, and investors will be watching closely for any signs of a reacceleration in case growth, or alternatively a signal that policymakers are considering closing the stimulus taps. As such, markets may trend higher in the short-run, but will likely be range bound until a medical solution has been developed and made available. The silver lining to all of this is that markets may be able to grow into the elevated valuations we are observing at the current juncture.

So where does this leave us? With volatility likely to remain elevated, we continue to advocate for a focus on quality with a dash of cyclicality. This should allow portfolios to weather the storm in the short/ medium term, while simultaneously maintaining enough cyclicality to participate when markets do rally.

We are optimistic about the financial markets and the economy and look forward to gathering with friends and sharing stories about how we entertained ourselves during the summer of 2020. We pray that we all get through this with good health and a positive spirit. Our experience goes back over 30+ years but we have previously never encountered a biological crisis. Hopefully, this is the last, but we will be prepared if something similar happens again. 

Being properly diversified is one of those timeless investing principles along with remaining focused on your goals is how we can weather all seasons economically, geo-politically, biologically, and otherwise. We firmly believe in our trademarked investment process, D3 The Power of Diversificationtm. This approach is intended to reduce volatility and enhance long term returns and has performed well through many different market cycles. Our role is to understand your goals and objectives, and then manage your portfolio and advise you, with those in mind.  It is especially important in times of volatility that we make sure your portfolio is aligned with your objectives. If you would like to schedule some time together, please give us a call. 

We want to sincerely thank you for your continued confidence in allowing us to serve you. We look forward to talking to you soon.


Jay W. Branson CFP®, ChFC


2nd Quarter Commentary 2020

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