At this time last year, it was still unknown that a deadly global pandemic was on the rise, eventually stalling economic growth and sending crude oil prices into negative territory. But recently, oil prices have surged, with crude hitting highs not seen since before the pandemic.

A Hopeful Sign

Recent production cuts and a belief in the potential for underlying economic growth are spurring a rally. Although the demand for oil is still lower than normal, many investment professionals harbor hopes of a speedier than expected economic recovery thanks to the ongoing global vaccination effort. (1)

Oil Prices and the Economy

The price of oil can often influence the costs of other production and manufacturing across the United States. For example, there is a direct correlation between the cost of gasoline or airplane fuel to the price of transporting goods and people. A drop in fuel prices means lower transport costs and cheaper airline tickets. (2)

The Ultimate Lead Indicator?

Some investment professionals view the value of oil as a lead indicator. Whether or not this will remain true for the future, it can be helpful to remember that lead indicators should never be seen as infallible. Abrupt and unexpected changes will prompt lead indicators to rapidly recalibrate their expectations for the future.

Sources

1. Barrons.com, February 8, 2021
2. Investopedia.com, January 8, 2021

These forecasts or forward-looking statements are based on assumptions, subject to revision without notice, and may not materialize.

Investing involves risks, and investment decisions should be based on your own goals, time horizon and tolerance for risk. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax, or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

It’s a new high, but not dissimilar to celebrating say, 29,999 as a new peak, although the odd number didn’t receive the same level of media attention. These round market levels, whether it be the Dow Jones Industrial Average, Nasdaq, or others, tend to generate high visibility (especially in the slower post-election news cycle). If an index is old enough, and tends to show positive performance (as stocks have over the long haul), you’ll end up reaching new and higher milestones. The seemingly-large 30,000 level is just a reflection of how long the index has been in existence. (It was first assembled in 1896 by its namesake Charles Dow, former Wall Street Journal editor, in a day where calculating the price levels of a dozen stocks by hand on paper was ‘cutting edge indexing.’) We won’t go into how the Dow is a less desirable index to track relative to others, due to its outdated price-weighted construction methodology and concentrated membership of 30 stocks, but it remains well-watched regardless due to this historical legacy. The S&P 500, more widely used by financial professionals, has gained public traction over time, but its lower and less sexy 3,000-ish level is simply a reflection of its more recent creation (early 1950’s). Total return percentages matter much more than index levels.

Fear and Greed

Most importantly, these announcements can often cause investors to react in one of two ways: (1) consider buying, after they’re reminded of their FOMO (‘fear of missing out’); or, (2) consider selling, as they see the new milestone high as feeling ‘expensive.’ Neither is an ideal approach, based on news coverage alone.

Market Realities

The new highs for several U.S. equity indexes are a reflection of the unusual year we’ve experienced. Following a dramatic (-33%) drawdown in March, stocks have recovered—and then some (+65%). The rebound triggers opposing investor emotions largely because of what this extreme movement represents, in realities on the ground as well as anticipated future realities. While fundamentals (revenues and earnings) have improved as lockdowns eased mid-year, we’re now in the throes of a second wave which could dampen the recovery outlook again. Yet, promising vaccine data gives markets more of what they really want, which is the removal of uncertainty about an ending point for the pandemic. If sometime in 2021 provides virus containment and herd immunity, today’s multiples are expected to ‘grow into’ 2021 and 2022 earnings expectations. The damage from the lockdowns earlier this year were such that higher-than-average recovery growth, at the current path, could be the case for several quarters, if not a few years. The Fed also looks to remain on hold during that time. As important as anything, low interest rates tend to be an extremely powerful and positive input into fair values for stocks and real estate

Smart Investing

With the end of the year approaching, it’s likely a good time to reevaluate portfolio positioning. Reacting to recent equity strength by a knee-jerk extreme of going ‘all in,’ or ‘getting out’ completely can be disruptive, especially since the second question of ‘now what?’ offers few alternative. Rather, if one’s risk allocation level needs to be adjusted, doing so by a notch or two can provide continued market exposure, yet not cause one to completely miss out on potential market gains over time (or even sharp movements from the ‘best days’). Stock market timing is extremely difficult, if not impossible. Therefore, any move that changes exposure to that growth engine, relative to the stabilizing force of bonds in portfolio creates risk-return trade-offs. ‘Regret’ is a real force discussed many times by economists involved in behavioral finance.

▲ Impact of Being out of The Market

During periods of extreme market declines, a natural emotional reaction can be to sell out of the market and seek safety in cash. The results of this reaction can be devastating because often the best days occur close to the worst days during periods of market volatility. This chart compares an individual who was fully invested for the past 20 years in the S&P 500 to investors who missed some of the best days as a result of being out of the market for a period of time. Missing the top 10 best days will halve the annualized return; missing the top 30 days will result in a negative annualized return on the original $10,000 investment. Rather than emotionally reacting to or trying to time the market, adopting a disciplined long-term investment strategy may produce a better retirement outcome.

Sources

1. LSA Portfolio Analytics
2. JP Morgan Asset Management: Guide to Retirement

Although they may appear to be disconnected on the surface, and near-term outcomes are impossible to predict, they’re likely no more disconnected than usual.

One of the more important considerations to keep in mind about financial markets is that they’ve always been forward looking. Economic data, by its nature and difficulty in tabulation, always reflects the past. Folks who sold in March probably don’t need a reminder of this, but many of the better buying opportunities for financial assets have surfaced during past recessions. As such, the state of the economy at the time had little bearing on prospects for future returns—in fact, the two are often negatively correlated. Additionally, by the time the recession is over, the larger discounts for risk assets are often long past.

Credit goes to Professor Jeremy Siegel at the Univ. of Pennsylvania (and author of Stocks for the Long Run) for the continual reminders of this during the time of Covid, but earnings for the next year or two represent a very small percentage of an underlying stock’s valuation (or for that of a broader stock index), when using a traditional dividend discount-type model. Although most investors aren’t modeling valuations constantly, the focus does remain on the future—the past is already done with and an investment’s value at any given point is reliant on longer-term future growth and cash flows. That said, with reopenings already occurring around the country (even if not working out ideally from a medical standpoint, especially during the last few weeks), the broader economy has moved on from deep self-imposed trough, and into recovery.

This recovery will likely be a gradual one, and as we’ve seen over the past few weeks, surprise virus hotspots, or comments from officials, may still result in market volatility. The main question now has moved from ‘if’ a recovery would happen, to still a degree of ‘when’ it would happen, as well as ‘how long’ it will take. The latter remains an open question, with social distancing and societal reluctance putting a damper on V-shaped sentiment. There will likely be additional bad news to come, especially for lower-margin businesses like restaurants and retail, where 25% or 50% of normal volume may not be enough to make ends meet. Additional government stimulus may be necessary (and is likely forthcoming), but there could be further economic damage for more indebted firms or others on the brink. Not every business can be saved—this is the nature of the risk involved with capitalism and unfair and unpredictable events. Just because the government has infused money into ‘fallen angel’ portions of the high yield bond market is not an all-clear signal for no more risk. This may also continue to exacerbate rotations away from challenged sectors, like brick and mortar retail, into new economy industries, such as certain segments of high tech, that have already been in progress prior to the pandemic.

(Click here for full report from PIMCO)

Another factor that has taken a back seat amidst the Covid news is the upcoming election. While many are hesitant to trust early results from polling (due to the surprise outcome that challenged the reliability of polls in 2016), former Vice President Biden has jumped to a substantial lead over President Trump—especially in key battleground states. Aside from the current divisive political landscape, financial market trepidation of a Biden presidency, and possible Democratic takeover of the Senate, are focused on the ‘Biden Tax Plan,’ which includes promises to re-raise corporate tax rates from 21% to 28% (albeit not all the way back up to the previous max 35%), and on the highest personal tax brackets. The direct impact is that a corporate tax increase would lower equity earnings, which lowers fair values. Naturally, with concerns over getting earnings back to normal in 2021, downward shocks aren’t being welcomed. Election probabilities will likely continue to be in the minds of investors through the summer and fall. Historically, recessions have been the Achilles heel of incumbent presidents for the last half-century, regardless of the cause.

(Click here for full report from Alliance Bernstein)

Financial market reactions were certainly as extreme as we’ve seen in decades over the past few months. With the medical landscape and prospects for a solution remaining uncertain, it would not be surprising to see volatility persist. As before, near-term financial market results remain generally tied to hopes/timing for a vaccine, further fiscal stimulus, and ‘normalization’ of life (financial and other). However, long-term results have been tied more closely to human innovation and ingenuity, which has been a difficult trend to derail.

Sources

1. https://www.dropbox.com/s/h2zn2tg7ti1sxb7/International%2BBond%2BFund%2B%28US%2BHedged%29%2BQIR.pdf?dl=0
2. https://www.dropbox.com/s/wp8148ldkh7a18o/CMO%20Presentation%203Q20.pdf?dl=0