Equity and balanced accounts outperformed their benchmarks during a robust third quarter. The overall environment was bolstered by the Fed’s continued wave of liquidity and a “V”- shaped recovery in economic activity. While our concentration in technology/growth stocks has been successful in general, holdings in two semiconductor stocks created particular value during the quarter. Our position in the leading provider of accelerated computing chips outperformed as its addressable market expanded beyond cloud and hyper scale users to enterprise and edge applications. Similarly, the preeminent provider of wireless phone technology delivered outsized gains due to the current transition to the 5G standard. As continued outperformance resulted in an increase in our technology sector weighting, we trimmed positions as a risk control measure. Nonetheless, we remain overweight this growth sector.
Looking forward, the only thing certain about the fourth quarter is that it holds much uncertainty. However, it is important to remember that capital markets have already identified the “known unknowns” and are likely to have already “discounted” or incorporated many of these issues into stock prices. Our take on these unknowns includes:
As of this writing, the market is gyrating with the prospects of a pre-election stimulus bill. Previous trillion dollar packages helped prevent a downward spiral in which job losses would have reduced spending, in turn forcing businesses to cut additional jobs. On a very near-term basis, passage faces steep odds since the clock is ticking and it requires the support of the President, Speaker of the House, and Senate Majority Leader, all with very different agendas. Although the current economic recovery may be slowing its brisk pace (“V”), the direction should remain intact regardless of immediate passage of stimulus. Investors are likely to view the issue of additional fiscal support as more of a “when” rather than an “if”. In other words, the likelihood of stimulus increases after the election, particularly under a “Blue Wave” scenario.
We do not pretend to know the outcome of the election, but Vice President Biden shows a double-digit lead in polling data as of this writing. Of course, President Trump’s victory defied predictions in 2016 but that does not mean he is preordained to win this year. He has a large margin to overcome with not much time remaining. Investors read the same polls so we doubt if they will be shocked by a change in administration. Polling also shows the Democratic Party as likely to gain control of the Senate but by a slim majority with several conservative members. In that case, a Democratic-controlled government will be viewed as less favorable for corporate profits. Biden has campaigned with a plan to reverse much of the 2017 Tax Act, including an increase in the corporate tax rate from 21% to 28%. If enacted as such (and it could be negotiated downward), estimates show a 6% to 7% hit to S&P 500 earnings, all else equal. However, all else will not be equal as the odds of stimulus and infrastructure packages increase under this scenario.
We can’t offer much insight into the progression of the pandemic. Infection rates within the United States vary widely state by state so predictions for the whole are difficult at best. New infections appear more concentrated in the younger population so mortality rates have been lower than earlier in the outbreak. The resurgence of the virus in countries like France demonstrates the difficulty of controlling COVID even with uniform national policy. It also reminds us of the economic threat of renewed shutdowns. However, from a market perspective, controlling the pandemic may be another “when” not “if” question. In other words, investors seem to be taking a longer-term view as they see continued progress in the development of vaccines and therapeutics.
The Fed has given us two out of the three pieces in the monetary policy puzzle. Interest rates will remain low for years and they will allow inflation to exceed their targeted range before acting. However, they have been coy about the future direction of asset purchases (quantitative easing) as they almost plead for more fiscal support. This can be viewed as gamesmanship because we doubt if the Fed has come this far only to come this far. Said differently, we believe that they continue to have the market’s back.
During the quarter, our portfolio continued to expand exposure to improving economic prospects, particularly in the industrial and material sectors. For the first time in years, we initiated a position in a utility stock but not for the defensive characteristics usually associated with the sector. Rather, we purchased a utility with a non-regulated business that is the world’s leading producer of clean energy. We anticipate an acceleration of its already strong backlog of wind and solar projects. Building on this base, clean hydrogen offers the potential to be another leg in the company’s growth for the out years.
As written earlier, there are plenty of unknowns to play out during the rest of the year so volatility may result. However, much of this may be in the rear view mirror over the course of 2021. A supportive Federal Reserve and a recovering economy are likely to be the durable and dominant factors.