The Great Reopening
by Richard Lerch
In June of 2020 I wrote in my last Partner Talk cover letter that “I am struck by how different things are compared to the last time I wrote in November of 2019 under the title of ‘Goldilocks Economy.’” Exactly one year later, the exact same sentence is surprisingly and, thankfully, just as relevant. June of 2021 is decidedly different, in a good way, than June of 2020.
One year ago, thanks to COVID-19, much of the world’s economies were largely shut-down. The U.S.’ financial markets suffered huge spikes in volatility, and unemployment went from historic lows to historic highs in a matter of months. Today, while we are not yet at the “Goldilocks” scenario we were enjoying at the end of 2019 and early 2020, we do seem to be experiencing a “Great Reopening” with COVID cases dropping, most businesses now permitted to operate at full capacity, some mask mandates being rescinded, corporate earnings looking strong, U.S. equity markets hovering near all-time highs again and the employment situation gradually improving. In fact, the well-known aphorism coined by Jean-Baptiste Alphonse Karr “plus ça change, plus c’est la même chose”, usually translated as “the more things change, the more they stay the same”, comes to mind.
This aphorism is one worth remembering when one is invested, for the long-term, in the financial markets. Although short-term volatility can be very painful to live through, until one is convinced that the United States will no longer be the greatest country with the greatest economy on earth, one should continue to be confident that the power of long-term compounding combined with a well-diversified, risk-controlled portfolio will likely lead to greater wealth, as long as one is able to stick to one’s investment plan during both good and not-so-good market scenarios.
Who could have ever predicted what would happen between February of 2020 and now in the economic, financial and political worlds and the resulting effects on the financial markets? Quite frankly, no one. And yet, we still see in the popular financial media outlets professional commentators and pundits continued attempts to do this. They likely do this because they get rewarded with higher ratings or more “clicks” on the internet which leads to more followers, more sponsors and more personal financial gain. However, if these prognosticators were paid based only on the accuracy of the future outcomes of their predictions, they would likely soon vanish because it would quickly become obvious how rarely their predictions were accurate. One of my favorite quotes about financial forecasting comes from John Kenneth Galbraith, “The only function of economic forecasting is to make astrology look respectable.”
Therefore, what is an investor to do? Our advice has remained consistent: stick to the prudent, risk-controlled investment plan that was developed for the long-term, because crises and resulting volatility will happen. If you avoid making decisions based on emotions and/or fear, which usually result in permanently destroying value, our belief is that you will have the best chance to weather the storm to the benefit of your portfolio over the long term. Hence, “The more things change, the more they stay the same.”
Although we don’t make investment decisions based on forecasts of what the markets will do in the future, this doesn’t mean that we aren’t tracking and analyzing much of the same financial, economic and political data as the so-called pundits are. In fact, we follow these metrics very closely. It’s just that we use this data differently. We use it to make reasonable assumptions about future expected risk and returns which guide us in constructing the asset allocation of our equity and fixed income portfolios.
Our most recent Investment Committee meeting took place on April 21st. Given the above, our current thoughts about the economy and the markets follow below.
The economy looks to be strong reflecting a healthy bounce-back from the pandemic. Economic growth, as measured by GDP, is forecasted to grow at an annualized rate of almost 7% for 2021, assuming that the number of COVID-19 cases has peaked and continues to steadily decrease. The primary source of downside risk for these forecasts is any unexpected problems relating to COVID-19. Looking forward, a concern is the possibility of higher inflation and an economic slowdown triggered by increased government spending and increased personal and business taxes. Additionally, increasingly large deficits are on the horizon. Such deficits, as they materialize, act to put downward pressure on market values and upward pressure on inflation and interest rates.
In 2020, even with the COVID pandemic, the S&P 500 returned 18.4%! 2021 has continued to be strong, with the S&P 500 returning 12.6% through May. PMA’s current expectation for the return of the stock market is around 6% over the next year. A key issue going forward, however, is the potential for greater than expected inflation. The concern is that higher inflation will lead to long-term bond yields increasing resulting in downward pressure on bond prices. See last month’s cover letter for a fuller discussion of the inflation issue. But, in general, there are two distinct schools of thought with respect to future inflation. One is that the current increased inflation that is appearing is transitory and is the result of a low base for prices caused by the pandemic. The other school of thought is that the combination of the liquidity inserted into the economy by the FED, increased government spending and increased taxes will lead to higher and longer lasting inflation moving forward. We are carefully monitoring this issue and are evaluating potential strategies including adding TIPS (Treasury Inflation-Protected Securities) to our fixed income portfolios.
Since PMA was founded almost forty years ago, we have approached investing with only one horizon in mind: the long-term. Key to this effort is the willingness and the ability to continue to steer the “ship” on the same course despite the real-world fears that come with economic, political, societal and health uncertainty and the resulting market volatility. Short-term investment decisions and so-called “tactical investing” often hurt investment performance. This means that the most prudent investment decision is often to hold fast and do nothing. To not make hasty, emotional decisions during times of uncertainty and pain is easier said than done. But, that is part of what we’ve advised our clients from the beginning. We are thankful for and appreciate your continued trust in our stewardship of your assets.