As the third period of 2020 comes to a close, I would like to share with Seeking Alpha readers the “markets and economy” piece of my two-page quarterly letter to DM Martins Multi-Asset Fund, L.P. limited partners. I hope that my observations and conclusions below can help investors fine-tune their own portfolio strategies.
At the end of the article, I also share a few parting thoughts and reiterate the lessons from the second quarter that I still believe to be relevant. Lastly, for compliance reasons, I will omit any portfolio-specific information regarding past returns and performance targets.
(Image Credit: Roberto Jr.)
In a few different ways, the third quarter of 2020 resembled the last half of the previous three-month period. The economic data continued to send mixed messages about the recovery, with a few pockets of strength helping to support optimism.
For example, activity in the residential real estate and home improvement spaces stayed strong – likely the result of rock-bottom interest rates and the refunnelling of consumer spending priorities. Demand for large-ticket items (e.g., automobiles) also looked robust, possibly for the same reasons. Even a sharp reduction in the unemployment rate, which dropped below the 8% mark ahead of the US Presidential election, caught many by surprise.
But every coin has two sides. Spending on consumer goods and services failed to recover substantially past the second quarter, dragged by a travel and leisure sector that remains deep under water. Fears over permanent job losses have started to grow, as the COVID-19 crisis proves resilient past its March peak. The lack of follow-on fiscal stimulus seems to be slowing down the pace of recovery further, with government leaders in D.C. failing to reach a consensus on the next package.
It took longer than I expected for the stock market to reflect the challenges that had started to mount since the peak summer months. The tech-rich Nasdaq index (QQQ) had its best month of August since the early dot-com correction days. I reason that “irrational exuberance” fueled this last leg of the rally, as large stocks like Apple (AAPL) and Tesla (TSLA) skyrocketed ahead of their stock splits and carried the rest of the market along for the ride.
But elsewhere not far away, a storm already was brewing. While the “everything rally” was still alive and well in July, many asset classes began to pull back by mid-quarter. Apart from stocks and a few other pro-cyclical assets, including industrial commodities (DBC) and commercial real estate (VNQ), August proved to be a tough month. Gold (GLD) tumbled, and Treasury prices dropped back to March levels. The signs were pointing at a risk-off shift in the markets before stocks felt the pinch, which was confirmed by a sudden spike in the VIX (volatility index) by late August.
September marked the end of the “melt-up” in stocks that had started in March. The Nasdaq index dropped 10% off its all-time peak in less than one week, the fastest correction of this magnitude ever. Not even multi-asset class diversification was effective at preventing substantial portfolio losses. It was hard to single out a long-only investment strategy that fared well during the last several weeks of the third quarter.
It’s against the backdrop of resurgent COVID-19 cases, economic uncertainty, political instability and increase in market volatility that we begin the fourth quarter of 2020. Portfolio management will remain a challenge, and the diligence to follow a well-constructed investment strategy will be even more valuable. While no one can know for sure what the future holds, having a contingency plan to sidestep large losses and maintaining a long-term perspective will be crucial.
Here are a few items to keep in mind for the quarter ahead:
- The markets have started to behave more erratically in the third quarter of 2020 after a truce in the second quarter, making it frustrating to second-guess price trends in the short term. As cliché as it may sound, expect the last period of the year to be marked by volatility and sideway movements in asset prices.
- I continue to favor (and advocate for) a rules-based investment system that’s properly backtested and agnostic to the portfolio manager’s personal convictions.
- I also believe that well-balanced investment strategies will perform better, at least in risk-adjusted terms, than speculative bets in riskier assets over the longer term.
- I maintain my conviction in the three pillars of a successful growth investment strategy: broad diversification, controlled use of leverage if appropriate, and low tolerance for sizable losses.
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Disclosure: I am/we are long AAPL, VTIP, CALL OPTIONS ON TLT AND GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.