December 2020 - Vaccines and Euripides
By Kyle McBurney, CFP
Managing Partner at Highland Peak Wealth
On October 29, popular CNBC talking head Josh Brown referred to a potential COVID-19 vaccine as a Deus ex Machina for markets. How perfect, I thought.
So, what is a Deus ex Machina?
This Latin term is an ancient plot device used in Greek and Roman theatre to instantly resolve complicated or hopeless situations. The phrase loosely translates as “god from the machine.” Quite a literal adaptation, as an actor would hover above the stage with the help of machines and ropes. As was usually the case, this supernatural presence would immediately solve an otherwise seemingly impossible challenge.
Pesky critics view this plot technique as lazy and haphazard, but this Latin phrase still lives in our modern-day vernacular. The term, in modern times, has taken on a broader meaning. Deus ex Machina is now the idiom used to describe any situation where something far-fetched or incredible occurs to resolve twisted circumstances. The resolution could come from a new character, device, or, dare I say, a medical discovery.
A near-term vaccine has the potential to swiftly cure many of our economic ills and provide 2020 with its own heaven-sent Deus ex Machina. Perhaps this simple outlook is a little too inartistic, but I think the stock market would agree with me.
Here are some of today’s totally ho-hum headlines –
“Dow Finished Best Month Since 1987” – Wall Street Journal
“Global Stocks Set for Best Month Ever” - Reuters
“Bitcoin Record, Small Cap Stocks Best Month Ever” – CNBC
Amid a slew of positive COVID-19 vaccine updates, lifting hopes of a robust economic recovery, the S&P 500 climbed 11% - the largest monthly advance since April. The Dow did even better, gaining 12% and touching 30,000 for the first time as it posted the best month since 1987. Previously beaten-down stocks and industries led the charge.
Looking further down, November was even better, with Mid-Cap and Small-Cap stocks soaring 14.2% and 20.5%, respectively. With the prospects of a vaccine seemingly improving every week, those “reopen” names such as airlines, casinos, hotels, cruises, and banks all had a gangbuster month. At first glance, this is the broadest rally we have seen since 2013, with 92% of the S&P 500 above its 200-day moving average. To quote Chris Verrone at Strategas, “everything has broken out.”
It has been a very impressive month everywhere you look. We should all take a moment to sit back and appreciate where we are. Markets like this don’t last forever.
Small-Cap Resurgence
As stated last month, this newsletter aims to accomplish several important goals. One of the more critical tasks is to correctly point out facts and figures that may not be well known. November’s small-cap resurrection is a significant market development and is worth exploring.
Small-cap US stocks generally have a market cap between $300 million to $2 billion. Given their smaller size, this group tends to be a higher risk/reward asset class than their larger peers. Recently, small-cap stocks have been a pesky drag on portfolio return, hurt by economic shutdown and a strong US dollar. This trend, however, shifted dramatically in November.
A bullish momentum thrust helped breakout small-cap US stocks from a two-and-one-half-year bear market. After a seven-year slumber, it looks like small stocks are finally waking up and providing investors with welcome returns. The Russell 2000 Index, the most popular small-cap stock benchmark, hit an all-time high in November, which will go down in the history books as the best calendar month ever. See below:
Source: CNBC
What I find especially interesting is the predictive power a small-cap rally can possess. When these smaller companies lead the way, their larger peers tend to be right behind. With history as our guide, small-cap stocks perform particularly well in the early stages of bull markets as economic growth surges. This breakdown is a particularly eye-catching graphic from Strategas:
Source: Strategas
Momentum matters in the stock market. As Newton put it in his first law of motion, “an object in motion tends to stay in motion.” The power of momentum has proven to be especially true when analyzing small-cap stocks and historical patterns. Past small-cap thrusts have set the wheels in motion for excellent Russell 2000 return in both the short-term and long-term.
So, what does this mean for your portfolio?
We increased our small-cap allocation back in November and plan to continue to grow our small-cap overweight as we approach the new year.
What I am Watching – Growth vs. Value
As portfolio managers, we continually debate our balance between growth and value stocks within our allocations. These seemingly minor tilts can add additional oomph in times of growth and protection in times of uncertainty.
First, I think it would be helpful to clarify the difference between growth and value stocks.
In simple terms, growth stocks are companies that can execute and grow regardless of the economic environment. Think of stocks like Amazon or Apple that can increase revenue even amid a worldwide pandemic or economic recession. As the name implies, value stocks tend to trade at lower multiples and are more sensitive to fluctuations in GDP and economic cycles. Banks are an excellent example of a value stock - it is hard for them to innovate or adapt to profitability. Instead, banks stocks tend to trade around variables out of their control, such as interest rates, housing market health, and overall economic growth.
For all of 2020, we have been overweight growth stocks. This tilt has proved to be beneficial across the board, as growth stocks have flourished. However, recent advancements around a COVID-19 vaccine have made this growth/value debate exceptionally pressing. With the potential of an economic reopening in 2021, value stocks’ re-evaluation is more than justified. As such, we are slowly abandoning the large-cap growth trade that has outperformed for so long. November’s performance speaks to this potential shift, with value stocks outperforming growth stocks by 5%.
After the election, our team at Highland Peak Wealth has begun the process of rebalancing our portfolios back into sectors and industries that have a tilt towards value. Our goal is to slowly and prudently lessen the gap between growth and value stocks within our portfolios.
This rebalancing process will be slow, as we see plenty of potential impediments ahead. Rising COVID cases and a growing call for regulatory action may worsen earnings in the short-term and unjustly punish value stocks. Also, any slowdown in vaccine development or deployment will undoubtedly create some near-term volatility. Add it all up, and we believe that there will be some better entry points to rebalance our portfolios through 2020 and into Q1 of 2021.
We will keep you informed as this develops.
The Santa Claus Rally
Will Santa be wearing a face mask this year?
Either way, ‘tis the season to reflect on seasonal trends in the stock market. For those unfamiliar, the Santa Claus Rally is industry jargon that speaks to December’s historically strong track record. It describes a sustained increase in the stock market that typically occurs in the last couple of weeks of the month. The chart from Strategas does an excellent job illustrating this seasonal pattern:
Source: Strategas
Several theories exist, including good ole holiday cheer and optimism, but there is some science behind this playful expression. There is a notable uptick of institutional trading in the back half of the month, as you can see above. These institutions are generally buying to position themselves for the upcoming calendar year. This simple portfolio maneuver may seem mundane, but 75% of the stock market is institutional money (surprising, I know), and therefore even minor reallocations can push markets higher.
Despite November’s furious rally, I expect December to follow its historical trend. With a potential vaccine on the way, I expect that many institutional investors will be looking to deploy cash to get ahead of market shifts.
As far as Santa Claus, someone should connect him with Jeff Bezos.
Allocation Update
The bullish tone of this month’s newsletter is not lost on me. Despite historical trends giving us the “green-light,” we remain well-diversified with a slight overweight in stocks. Our modest overweight is a result of stock market growth and cash investment. As mentioned last month, the cash we raised before the election has been redeployed back into equities. Following Pfizer’s update, we moved more into small-cap and value stocks. As we enter 2021, we expect this trend to continue. Of course, we will keep you updated along the way.
As risk managers, we are aware of stretched equity valuations and timing uncertainty around vaccines/fiscal stimulus. While forecasters are becoming more and more bullish heading into 2021, we are aware of the risk of overconfidence. We are not there yet, but some yellow lights are flashing, particularly around wonky indicators such as the Bull/Bear Ratio and the 10-Day Put/Call Ratio. For your sake, I won’t get into these topics. After all, we pay attention to this fun boring stuff, so you don’t have to!
In addition to holiday shopping, December marks the time of year when our team pays particularly close attention to tax-loss harvesting. We are currently going through each account to see what trades are available to lessen your tax bill. The strong recovery of 2020 has not left us much, but every little bit helps.
I hope that you all had an enjoyable Thanksgiving holiday. Given the state of things, I think we can all agree that there is much to be thankful for. Teddy enjoyed his first authentic Thanksgiving dinner. Although, true to form, he didn’t touch any of it and instead splurged on goldfish and popcorn (just as the Pilgrims and Native Americans intended, I suppose). Otherwise, the McBurney clan enjoyed a quiet week but missed some of the typical festivities. I don’t suppose that I will ever take a touch football game or “leftovers” party for granted ever again!
As we approach the holiday season, we want to thank you for all your trust and support. It has certainly been an exciting year, both personally and professionally. I wouldn’t have it any other way.
To reiterate last month’s closing, our lines of communication are always open. Calendar year 2020 is far from over. It strains gullibility to think that a year filled with surprises will stop providing them now.
As always, I welcome any and all thoughts and criticisms.
Best,
Kyle M. McBurney, CFP®
Managing Partner
The opinions expressed herein are those of Kyle McBurney, CFP as of the date of writing and are subject to change. This commentary is brought to you courtesy of Highland Peak Wealth which offers securities and investment advisory services through registered representatives of MML Investors Services, LLC (Member FINRA, Member SIPC). Past performance is not indicative of future performance. Information presented herein is meant for informational purposes only and should not be construed as specific tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, it is not guaranteed. Please note that individual situations can vary, therefore, the information should only be relied upon when coordinated with individual professional advice. This material may contain forward looking statements that are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Referenced indexes, such as the S&P 500, are unmanaged and their performance reflects the reinvestment of dividends and interest. Individuals cannot invest directly in an index.
CRN202012-275273.