In September, following the S&P 500’s rise of 60% in less than six months, stocks saw the deepest pullback since this bull market began. As discussed last month, stocks were extended short term, and rising investor complacency made markets vulnerable to a setback. The good news is that the subsequent pullback has served to reset some of the excesses in price, sentiment and valuation.
Markets, though, are set to remain bumpy near term. Volatility has risen in October during every presidential election year since 1992, and if the election results are dragged out, that could result in a short-term disruption. Despite this uncertainty, we remain focused on the primary trend, which remains positive. Elections matter, but our work strongly suggests that the path of the economy and market fundamentals, among other factors such as monetary policy and relative valuations, are more important than the political backdrop in Washington.
Our base case remains that we are in the midst of a multi-year bull market, consistent with the early stages of an economic recovery. Notably, economic expansions since WWII have averaged longer than five years, and stocks have risen 85% of the time when the economy is growing. Moreover, global earnings momentum is the strongest since the early stages of the bull market that began in 2009. This trend should be further supported by the aforementioned economic recovery.
Consequently, we continue to favor stocks relative to cash and bonds on a 12-month basis. We would advise investors who are underweight equities to use stock volatility to average into the market. There is a high price to be paid for perceived certainty. Once clarity arrives, the market has often already moved.
Conversely, with yields near record lows, and the return outlook subpar, we have further downshifted our view of fixed income, though high quality bonds remain an important portfolio ballast, and we still see relative value in credit. We also have moved to a favorable view of gold, which provides some diversifying benefits. With short-term interest rates in the US pegged around zero, the opportunity cost for gold has receded. It also provides a partial hedge against uncertainty related to the election, another COVID spike and growing deficits. Investors, though, should note that the volatility and drawdowns for gold historically have tended to be much more severe than high quality fixed income, so the nomenclature calling gold a safe haven asset should be used with care. If technical trends for gold turn negative or the economic backdrop shifts, our view could change relatively quickly.
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