June 5, 2020
“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria” is a quote attributed to legendary investor, Sir John Templeton. This quote is as apt now as ever. After falling at a record pace, stocks formed a bottom in March as uncertainty and pessimism spiked. The subsequent record rally has been met with great skepticism given it has taken place during a once-in-a-generation pandemic, the sharpest economic decline in history, rising geopolitical tensions and civil unrest.

A disconnect at inflection points between the market and the economy is typical, even while the current period is magnified. Markets are forward looking and have risen, on average, five months before the end of a recession and often as the news flow has remained bleak. Our view is that this will likely be looked back upon as the sharpest but also the shortest recession in history, likely ending during the summer months. The end of a recession simply means that the worst is behind us and the economy has troughed. Trends are already broadly stabilizing, albeit from very depressed levels. However, the repair process and recapturing the prior level of economic activity will take time while the devastating effects of the downturn will linger.

Nevertheless, the end of the recession combined with the extreme pessimism in March and the extreme oversold conditions that were met with an aggressive policy response is what tends to happen at the onset of a bull market (even though everything appears to be happening at warp speed today). Moreover, the first part of a bull market tends to be the sharpest and is a sign of underlying strength. Notably, the path from the March low is on par with the strongest previous bull markets and the initial trajectory following the 1982 and 2009 lows.

Thus, our base case is we are indeed in a bull market. A bull market that started in March and likely has further to go. However, even in bull markets, there are ebbs and flows along with risks. While stocks remain attractive relative to most other asset classes, valuations are elevated on an absolute basis. There is also still a possibility that we see a coronavirus reinfection wave in the fall, and the election season is set to inject volatility into the markets later this year while China-US tensions are escalating.

Pulling this all together, we advise investors to remain overweight equities relative to fixed income and cash. While remaining overweight, as stocks get extended from target allocations, periodic and disciplined rebalancing of assets should be considered to mitigate risks. For investors with excess cash, we advocate an averaging-in approach. We still favor US equities longer term, but incrementally the outlook for the international developed markets is improving as the European and Japanese stimulus response is expanding. Likewise, we maintain a large cap bias and a modest growth tilt. That said, following the extreme underperformance seen in small caps, value, and international markets, their recent rebound likely has further to go near term. High quality bonds should provide portfolio ballast during the inevitable market pullbacks. Although the opportunity has lessened, we still see incremental value in investment grade and high yield bonds.

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