With investor anxiety and hedging activity elevated entering November, clarity on the presidential election and upbeat vaccine trial developments propelled stocks to record highs. The S&P 500 saw its best November return since 1928. The Dow Jones Industrial Average surpassed the 30,000 milestone, and posted its best monthly gain since 1987. Beaten-up areas—such as airlines, hotels, financials, energy, industrials and small caps—had epic rallies while “stay at home” beneficiaries, such as technology, lagged. High yield bonds had the best month since July. The Volatility Index (VIX) fell 45%, the sharpest one-month drop in the history of the data that goes back to 1990.
Among the primary reasons we have remained positive this year, despite a litany of uncertainties, is history shows elections tend to be a sideshow to the business cycle, which currently appears to be in early expansion, as well as our optimism on the vaccine front. The significant resources deployed on finding a solution to the pandemic is now paying off in spades.
While there is much to look forward to, near-term challenges remain. The surge in COVID-19 cases is set to weigh on short-term economic activity. Senate control remains unresolved, and the fiscal stimulus stalemate continues, though talks are ongoing. Market sentiment is also showing some signs of froth, as individual investor bullishness reached multi-year highs in November. While only one factor, elevated expectations leave the market more vulnerable to unexpected bad news.
Still, the weight of the evidence suggests the primary trend remains higher. Importantly, there is light at the end of the tunnel on the pandemic. This should allow investors to look past some of the weakening near-term trends given stocks are typically valued on cash flow generation over multiple years. Moreover, strong price momentum, as we have seen recently, has tended to be a very good sign for markets when looking out over the next 12 months. Monetary policy remains supportive, earnings are rising, and relative valuations continue to favor stocks. For those investors working excess cash into the market, we would average in and look to be more aggressive on pullbacks.
From a positioning standpoint, we retain an equity bias relative to fixed income with a US tilt. We upgraded our tactical view of small caps recently and would view pullbacks as opportunities to position for the year ahead; relative valuations appear very attractive, comparative earnings and price trends are rising, and sector composition is supportive. Small caps should create an effective barbell between growth and cyclical exposure. We are maintaining, though closely monitoring, gold, which we have been viewing as a portfolio diversifier and hedge. It has lagged, though, as one might expect given most of the recent market surprises have been positively skewed. Although less attractive, we still advise holding some high-quality fixed income as portfolio ballast. After a very strong month, the opportunity in credit has diminished, but we still see incremental value given yield pickup and an early-stage economic recovery.
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