October 6, 2020
Princeton Global Third Quarter 2020 Investor Letter
Equity markets continued to recover during the third quarter with a modest retracement in September. The markets responded favorably to evidence of recovery in the global economy, although levels remain well below the pre-pandemic peaks. Emerging markets rebounded in the third quarter, while the U.S. stock market leadership over international developed markets continued. Mega-Cap Technology stocks continue to drive the U.S. and Emerging Markets performance:
While global economies continue to recover, the return to pre-pandemic levels will await the achievement of “herd immunity” against the COVID-19 virus. This milestone necessitates the successful vaccination of a significant majority of the global population, generally believed to be at least 70%. A recent estimate by the World Health Organization is that COVID-19 has infected only 10% of the world’s population. The best-case scenario would be that an effective vaccine is introduced sometime during the fourth quarter of this year, with distribution and actual vaccination of large numbers of people next year.
In the meantime, there is evidence that the economic recovery in the U.S. is slowing. The U.S. payroll report released on October 3 indicates that of the 22 million jobs lost in March, 11.4 million have been replaced. Additional fiscal stimulus will be required to minimize new job losses in the travel, hospitality, and state and local government sectors. It is believed that the President’s illness improves the potential for an agreement on stimulus to be achieved pre-election on November 3. In the meantime, the U.S. equity market will be volatile, reflecting the potential for stimulus, the President’s health, and the election’s perceived outcome. A close Presidential election will extend volatility into the post-election period.
Notwithstanding volatility, downside risk in the U.S. stock market is limited by the Federal Reserve’s highly stimulative monetary policy. Under the new guidelines announced in September, the Federal Reserve will help employment recover to pre-pandemic levels, allowing inflation to exceed the 2% level for an extended period. This change implies that there will be no tightening in monetary policy in the foreseeable future, which previously would have been implemented to preempt a resurgence of inflation.
Historically low yields across the entire spectrum of the fixed income market mean a lack of attractive alternatives to common stocks. Even taking yield alone, the 1.9% dividend yield on the MSCI All Country World Index compares highly favorably with the 0.9% interest yield of the Global Aggregate Bond Index and the 0.7% interest yield on 10-year U.S. Treasury notes. Johnson & Johnson, one of the few AAA-rated companies, recently issued five-year bonds at an interest rate of 0.55% – a positive for J&J, but not bond investors. The lack of alternatives to stocks should also limit downside risk, especially as pension funds and large institutions will need to rebalance away from bonds towards stocks and other assets to meet return targets. We believe it is prudent to maintain a substantial allocation to equities and consider alternatives to traditional bonds for portfolio diversification, including precious metals.
Over the past decade, pension funds have edged away from stocks, even as the market has climbed. We expect this to reverse:
Source: The Wall Street Journal, Investment Metrics, As of June 30 each year
Within the equity market, price action will reflect the “K” shape of the recovery with a significant disparity among sectors. Strong sectors include technology, consumer staples, and homebuilding, while sectors related to services, hospitality, travel, and entertainment remain under pressure. For the weaker sectors to recover and contribute to an improved total economy, confidence in the pandemic’s taming must increase, reflecting progress on the vaccine front.
Globally, the Chinese economy has fared better than others and is expected to exhibit actual expansion for 2020. This trend reflects the apparent success of China in limiting the spread of COVID-19. The economic performance of Europe is more mixed, again depending on the infection trend. Other than China, emerging markets remain hard hit by the pandemic, resulting in a reversal of the decades-long trend toward reducing poverty rates. The successful development, distribution, and application of vaccines against COVID-19 will be the key to the global economy’s ability to return to pre-pandemic levels. We continue to prefer the U.S. for developed market exposure and emerging markets for international exposure.
We continue to view Quality as an essential characteristic of our equity positioning and new purchases. During the third quarter, we had low turnover in our strategies while continuing our efforts to invest in companies that will emerge from the recession in a position of strength. We have maintained considerable overweights in the Health Care and Information Technology sectors. We have recently added to stocks in the Industrials sector, which we believe are beneficiaries of future stimulus packages, particularly for infrastructure projects.
As we highlighted in last quarter’s investor letter, market returns during Democratic and Republican President four-year terms are similar with some turbulence around elections and inauguration years. We do not plan dramatic changes to our strategies based on election outcomes, but we focus on the candidates’ and parties’ policies. Therefore, we are incrementally modifying our industry preferences that will be less impacted or positively impacted by high probability policy changes. An example is our preference for medical devices over big pharma within the Health Care sector.
We have a high level of conviction in equity investments centered around dividend growth, and we have been adding to dividend growth style stocks across our strategies. In 2020 and the prior several years, the S&P 500’s leadership has been very narrow and driven by faster-growing stocks with richer valuations. Empirical data shows narrow growth leadership is not sustainable for prolonged periods, as these growth darlings will struggle to justify their valuations. The timing is uncertain, but leadership will likely change to other market segments. We are preparing for this change with diversified exposure across stock factors and styles. A reliable proxy for dividend growth stocks is the Dividend Aristocrats, a select group of S&P 500 stocks with 25+ years of consecutive dividend increases. The Dividend Aristocrats tend to underperform when the market valuations rise (the current market environment) and outperform when markets are volatile, and valuations compress. If we are in the midst of a “mini-tech bubble,” dividend growth stocks should be attractive, particularly with a backdrop of low short-term interest rates.
Source: Princeton Global, Bloomberg. *Since Inception 12/31/1989, Annualized.
Fixed Income Strategy
There was little change in U.S. fixed income yields during the third quarter. As of September 30, the yield on two-year Treasury notes was 0.1%, while the yields on five, ten, and thirty-year obligations were 0.3%, 0.7%, and 1.5%, respectively. Only in the thirty-year yields changed more than 0.1% from June 30, when the yield was 1.4%.
As indicated previously, we expect the Federal Reserve to adhere to a highly accommodative monetary policy emphasizing full employment over inflation for an extended period. Given this outlook, there is little prospect of an interest rate rise from current historically low levels. As a result, fixed-income securities risk is heavily skewed to downside price risk with limited yield. Given this condition, we continue to maintain below average duration in our taxable and tax-exempt fixed income portfolios.
Credit spreads are also tighter than the current economic environment would predicate due to the Federal Reserve’s purchase of corporate bonds, including “junk” bonds. Therefore, we prefer high-quality, fixed income investments for portfolio ballast over yield. We are selectively supplementing the core bond holdings with higher-yielding fixed income investments, including our liking of preferred stocks.
Princeton Global Asset Management, LLC
This report is for informational purposes only and contains data based on information Princeton Global Asset Management (PGAM) believed to be accurate. However, PGAM cannot assure the accuracy of the data.
Past performance is not a guarantee of future results. Portfolio holdings and characteristics are subject to change. The information in this report should not be considered a recommendation to purchase or sell any particular security.
It should not be assumed that any of these securities transactions or holdings that may be cited were or will prove to be profitable. The investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of securities cited.