June 2020 Newsletter to Clients

Enjoy this month’s edition that features a notice of a fund change and a review of the market.

Fund change: Starting this month we will start the process of switching from one large cap value fund – American Century Value (TWVLX) to another we believe will serve us all better going forward. The fund is BMO Low Volatility Equity Fund (MLVEX/BLVAX). The new fund is a 5-star Morningstar-rated fund that we believe will pair nicely with our other primary large cap growth fund – T. Rowe Price Blue Chip fund (TRBCX). As always, this decision was made after much research, discussion with the fund companies themselves and evaluation of performance over a number of years.

Market review: While over 40 million people have filed for unemployment over the last few weeks across the nation, the non-partisan Congressional Budget Office announced at the first of the month they expect Gross Domestic Product to decline over $16 Trillion over the next decade. And, yet, the stock market has performed stunningly well. Why the disconnect?

First, let’s review the numbers through the end of May:

• The large cap S&P 500 is down 4.98% Year-to-Date. Stocks considered S&P 500 value stocks are down 14.71%;
• The Small Cap 600 Growth index has declined 14.79% and its partner, the S&P Small Cap Value index has declined a whopping 27.14%
• The MSCI World index (without the U.S.) has declined 14.85%;
• Bonds, however, after a market liquidity scare early in the pandemic have steadied with U.S. Treasuries up over 5% Year-to-Date, U.S. Corporate Investment Grade bonds up 3%;
• U.S. High-Yield bonds are the weak link so far as they have dropped 4.73%.

One way to value the stock market is with the name only a mother could love, Cyclically Adjusted Price-Earnings Ratio (CAPE ratio). The CAPE is widely used to measure the collective price of the S&P 500 group of companies based on their average, inflation-adjusted earnings over the last 10 years. Using that measurement, the current CAPE ratio of 28.81 is well over its average of 16.71 but still well below its all-time high of 44.19, just before the 2000 stock market crash. To add perspective, the ratio is based on past earnings. Future earnings will assuredly be lower this year and possibly much longer.

So, why is the stock market so relatively expensive now? Probably a couple of reasons. First, over 95% of the daily stock trading is by institutional investors like pension funds and insurance companies who trade huge chunks of stocks at a time. And those institutional investors can afford to look at company earnings over a long period of time – 2, 3, 5 years – not simply what is likely to happen next week. Second, and maybe more important, is with bond yields historically low, many investors see stocks as the only asset class where one can make a reasonable return. When a 30-year U.S. bond pays only 1.41% per year and a 1-year note pays an anemic 0.65% per year, investors are willing to take on more risk in the stock market in order to stretch for the earnings they need.

A significant portion of investment decisions are made based on not what is great, but what is best among a finite set of choices. Today, stocks are probably over-priced, but compared with bonds they still may be the only viable choice for some investors. Particularly pensions funds, endowments and insurance companies that have to make a certain level of return in order to be able to meet their ongoing commitments. So, with most everyone agreeing they expect interest rates to remain low for the foreseeable future, the mega-investors who dominate the daily stock market fluctuations just may not have any place else to go. 

Thank you for your continuing confidence.