Round II COVID-19 vs The Stock Market Q&A
Dear Friends,
As someone who has been managing portfolios for over 45 years,
I have seen many different kinds of markets, some strong, some weak. I like to believe our successful investing experience helps when times are difficult, such as now. Our experience also helps us identify special opportunities. We view markets like the weather, sometimes it is great to be outdoors and at other times it is most prudent to be out of the storm, and to be well protected from the elements. We believe it is imperative to protect the moat around your castle, or in this case, the monies in your portfolio.
The following are questions that have been asked of me by friends and clients that I would like to address. Let’s get into it.
Q: After retreating in February, the markets had been strong since March 20 th . Now that they are retreating again, how should an investor be positioned looking out for the next 12 months?
A: We believe the markets as a whole will be choppy near term, with lots of back and forth, but they will pace higher over the next 12 months. We also believe it is important to use market pullbacks of 5 to 10% to add to positions where we have a strong conviction. At NIM, besides equities we also like selective fixed income, cash and gold. At this time, we like a combination of “growth companies” (our primary leaning) and “value companies”, and we particularly like the stay at home economy companies with sustainable revenue and earnings.
At the current time in our CORE Strategy we are about 70% invested, in our VALUE Strategy we are 80% invested and in our GROWTH Strategy around 70% invested.
Q: Why is the market up since March? Does this make sense with COVID resurgence, the elections, etc.?
A: The Bear Case has never been more obvious. COVID-19 cases are hitting record levels. COVID is causing the economy to slow and some of the businesses which did re-open now need to close again. People are being impacted and for many, it is a really tough time, and it is not over yet.
Despite this negative news the markets gears are grinding higher.
You have probably heard of “markets climbing the wall of worry”, well this is certainly a good example of this. The markets as of this writing are ahead of themselves, but we are not expecting a major pullback. Most of the facts still favor a higher market over the next 12 months as the economy gradually improves. Overall, we want to buy on weakness. The market’s current strength is supported by the following:
The Federal Reserve Board (The Fed), has said they will keep interest rates close to 0% thru 2022.
Besides interest rate cuts, there have been a number of credit and lending programs that could ultimately inject more than $6 trillion into the economy.
With these monetary injections, the Fed has also been a huge buyer of corporate debt, thereby supporting the U.S. economy’s financial plumbing, and supporting public companies.
Combined with the $6 trillion put into the economy by the Fed and Congress, the Fed is supporting the U.S. economy with a safety net underneath it with continual liquidity as needed. The Fed has the economy’s back so to speak. Keep in mind, as of this writing the Fed has only used a portion of their resources.
The net result is the U.S. economy has lots of liquidity at the moment.
Most investors have been way under-invested in equities.
And lastly, where else can you put your money when the U.S. Treasury 10 year is yielding approximately .6%.
Our position is we need to be invested but do it in such a way as to protect the castle.
And regarding a COVID vaccine: Although we have many very good companies in the U.S. and abroad working on a vaccine and we are optimistic a vaccine will be developed; no-one really knows when we will have one. Our view is that we need to factor this into how we invest. Once a vaccine looks to be promising and available, the markets will rise. With that said, we do believe the markets are at least 5 to 10% overvalued at present, and we will use pullbacks to enhance or establish new positions. The markets reflect where they believe the economy will be in 9 to 12 months, and in our opinion, we do believe the economy will be stronger in 9 to 18 months than it is now.
Q: If the U.S. has a democratic blue wave sweep, how do you feel it will affect the markets?
A: Goldman Sachs (GS), an investment bank, has told their clients if the democrats sweep all three branches of government you can expect corporate taxes will go back up to 28% from 19%. This will have the net effect of obviously reducing corporate profits. GS also discussed the effect of higher corporate regulatory costs and the financial impact on some companies .
Q: What is your forecast over the next 12 to 18 months in the Equity Markets?
A: All things considered, we do believe the equity markets will climb higher, very possibly much higher. We also believe it is very important to own companies which have the ability to accelerate their earnings in this environment as opposed to owning an ETF.
I expect many companies will do well, and some will underperform. Regarding the averages, I could easily see the NASDAQ and the Dow Jones both up around 10 to 15% by the end of 2021.
Q: What should my asset allocation be between real estate, equities, fixed income, precious metals, and cash?
A: Part of the answer is dependent on the age when you plan on retiring (if not already retired), your risk tolerance and your overall resources. For most people, I would recommend keeping a reserve of six to nine months of cash available, particularly in the environment we are in. After your cash reserves, I would divide as follows: 50 to 80% in equities and selective fixed income, 20 to 50% in real estate, including your primary residence. In our portfolios, we also like to own gold through an ETF due to its resiliency in turbulent situations. As you plan, keep in mind that your equities, fixed income and gold ETFs are generally liquid, and your real estate is generally not liquid.
Q: Should I own individual stocks or ETFs?
A: I believe for most people owning individual stocks versus Exchange Traded Funds (ETF’s) is preferable. But ETFs do have their place, and we do use them selectively. For example, if you want to own gold, the best way in our opinion is in an ETF. Or, if you want a broad selection of higher risk companies such as in the biotech sector, an ETF can be a great way to invest. Or, if you want specific country exposure, an ETF is the best way to go. But, for a reasonable sized portfolio of over $250,000, you should own individual stocks.
Keep in mind many ETFs are not well diversified. For example, the S&P 500 (SPY) top 5 companies represent 22% of the portfolio, meaning 495 companies represent the other 78%. These five companies have been taking the Nasdaq composite to new heights: Microsoft, Apple, Amazon, Facebook, and Google.
Q: With what seems to be the second wave of the virus starting to hit us, how will the markets react?
A: The markets react to the direction the virus is taking and the media coverage. For market purposes, less bad news will be interpreted positively by the markets. So for example, when the news is negative and unexpected, the market may react negatively. But as the news improves, even modestly, the markets will react more favorably.
Q: With the Federal Reserve and Congress spending $6 trillion on the economy won’t this cause considerable inflation?
A: We are in a deflationary environment at present, and the stimulus is keeping the economy afloat. If you look at the U.S. Treasury 10-year bond, you will note the yield is around .64%, certainly not an inflationary yield at the moment. When we started the year, the U.S. 10-year bond was at about 2%. For now, I would say inflation is not one of our problems. At the earliest, it seems like it will be at least 2022 before there is an issue.
Q: What should my investment expectations be if I have a five-year time horizon?
A: As a country, the U.S. is very resilient. My expectation would be for the U.S. to get back to normal sooner than many are expecting. We have superb biopharma companies working on the vaccine, an important element of our recovery. If you can stay with a five-year time frame you should do very well from the current levels and see strong returns. Part of this is based on your risk profile, but I am very bullish over a five-year period.
These are turbulent times, and I fully expect more questions to arise as situations change. Please reach out to me at 415-287-5105 or at brucen@nollenberger-im.com, with any questions or concerns you may have, or if there is a topic you would like to discuss in more detail. We are active and engaged, and are here to help you successfully navigate through the turbulence.
And most importantly, we hope you and your family stay healthy and safe.
Best,
Bruce
Bruce Nollenberger
brucen@nollenberger-im.com