Addressing Key Concerns for Investors
Some key concerns affecting investors currently include:
- Heightened stock valuations: Are we in a bubble?
- Will the presidential election swing markets severely?
- How should we allocate in a low interest rate environment?
As an example, with our four-bucket framework, we can more easily evaluate these three concerns and make portfolio decisions.
Heightened Stock Valuations: Are We In A Bubble?
The COVID pandemic was the definition of a black swan scenario. While most stocks haven’t fully regained their March levels, positive returns from the trough reflect the makings of a V-shaped recovery for equities.
Often confused by investors, the stock market and economy are not 100% correlated. Investors see the pain the economy is suffering. COVID has proven to be less of a problem for the stock market than the economy in the short term, however.
Driving factors for strong stock recovery include S&P 500 concentration in sectors that are COVID protected, the perpetual nature of stock ownership benefiting from low interest rates and flush liquidity.
As discussed above, the recovery has pushed valuations on large cap U.S. growth stocks historically high. These heightened valuations have raised fear that a bubble could exist in stocks.
Despite the hefty valuations, we believe there’s relatively balanced risk of heightened valuations and opportunity for continued leadership of large cap growth stocks.
Only time will tell how things play out, but we believe long-term investors can’t afford to take an allocation bet against large cap growth stocks. Valuations were historically high five years ago, and growth stocks have only pushed to new highs since.
If a bubble exists, it doesn’t appear the Federal Reserve would do the popping. The Fed has been “all in” at the poker table since the crisis started.
Its recent policy change regarding inflation targets and full employment treatment supports the premise it will continue to be “all in,” at least for the foreseeable future. Fed support bodes well for growth stocks.
Will The Presidential Election Swing Markets Severely?
It’s no secret the upcoming election is monumental. The White House, about one-third of the Senate, and the House of Representatives are all on the ballot. The two presidential candidates have stark differences in policy perspectives, especially with respect to taxes.
While there are many reasons to doubt the polls, it is never a waste of time to think about what tax policy would look like with different administrations, and how that would affect the economy and markets.
If Biden wins, but the GOP retains the Senate (right now, Republicans have 53 seats), the answer is likely very little change.
What many investors are focused on is a scenario where Biden wins and the Democrats take the Senate, called the “blue wave.” In that scenario, the Democrats could use the special budget process on Capitol Hill to raise taxes permanently (meaning no natural sunset) with a simple majority, like President Clinton did in 1993.
The biggest focus for investors is Biden’s proposal to raise the corporate tax rate to 28% from 21%. A 7% increase in corporate tax rates should have a direct impact on earnings; thus, it would impact valuations and stock prices.
The concern is the increase in corporate tax rates could cause a significant pullback for stocks.
We are still two months away from the election and much can happen. Likewise, regardless of the winner, it’s not a sure thing what the winner will do and how quickly he will do it.
As portfolio managers, we’re focused on analyzing the potential impact of a blue wave or a victory by the incumbents on stocks, and preparing to manage the risk of either scenario.
How Should We Allocate In A Low Interest Rate Environment?
As a result of low rates, several have investors asked:
Should I hold bonds at all?
Is 70/30 the new 60/40?
Historically, low interest rates have left investors with little yield and heightened duration risk. If we run “from” bonds, should we run “to” stocks? Some would say yes.
For the first time since 1959, the yield on S&P 500 stocks is higher than yields on 10-year U.S. Treasuries (Barclays and S&P). This is not because the S&P 500 yields have skyrocketed. Rates are low, changing the risk versus reward payoff for stock ownership versus bonds.
But what about those hefty valuations on large cap growth stocks and issues facing stocks overall?
While adding equity exposure makes sense to some, it doesn’t come without risk. Our assumptions for our well-diversified fixed income portfolios still put equity risk far above that of bonds.
4 Buckets As The Game Plan
We need to allocate 100% of the portfolio, and we think the solution should include all four buckets.
The S&P 500 closed Sept. 11 at 3341. A recent article in Barron’s, titled “Wall Street Strategists Say There Are Few Gains Ahead for the S&P 500: Here’s What Else They Expect,” provided a consensus estimate year-end target of 3492. Likewise, the article highlights consensus predictions of 3800 to 3850 for 2021, and consensus S&P 500 earnings estimates of $128 for 2020 and $161 for 2021.
If the strategists are correct, investors will want to be in stocks to reach their goals. To play this market, we can look to the four buckets for the most prudent game plan.
Is bucket 1 overvalued and out of steam? Maybe. However, there’s also a substantial probability that bucket 1 continues to do well, justifying appropriate exposure.
Is it finally the time for bucket 2 to lead? Valuations would foreshadow outperformance for bucket 2 in the next full cycle, providing a nice portfolio balance to exposure in bucket 1. Many of the institutional partners we work with have higher expected returns on bucket 2, given these valuations.
Should we get rid of bonds? For most investors, we think the answer is no. The paycheck (interest rates) for holding bucket 3 is low; however, bonds remain a quality diversifier and “flight to quality” asset. We would encourage investors to think hard before increasing naked stock exposure significantly simply to run “from” bonds.
The secret sauce going forward may be in bucket 4. Bucket 4 is a unique and innovative way to allow investors to increase equity exposure, while maintaining a floor in value. We believe bucket 4 will become an essential tool of portfolio management. Our TOPS Equity Target Floor Indexes are designed as the leading tool for this type of offering.
Bucket 4 can be used to replace some bond exposure, complement a well-diversified balanced portfolio or equitize cash that was sitting on the sidelines for fear of significant downturns.
As we look at the four buckets, we see different stories. Given these concerns, and others we see in the market, we feel the best plan of action is to combine our 4 buckets into cohesive portfolios.
Vince Lombardi once said, “The measure of who we are is what we do with what we have.”
The three concerns above are real, as are many others we face as investors. Of the tools available, the four buckets above are key tools for us.
We remain steadfast in providing appropriate risk-adjusted returns for our investors over multiple investment cycles, including this one. By using the four buckets and understanding the benefits and drawbacks of each, we feel we can best manage through the current market environment.
ValMark Advisers Inc. is the manager of the TOPS Portfolios of ETFs. ValMark started managing "TOPS" separately managed accounts of ETFs in 2002. The firm manages more than $5 billion in ETFs for retail and institutional clients in multiple investment products. Email: [email protected]; phone: 800-765-5201.