Bottom Line The Federated Hermes’ PRISM® asset allocation committee met Wednesday and reduced its equity overweight from 3% to 2% in its moderate growth portfolio. After plunging 35% from its record high on Feb. 19 to its recent low on March 23 (the fastest decline from a record high to a bear market in history), the S&P 500 then turned on a dime, rebounding more than 47% through June 8, marking its sharpest 50-day rally in history. This market appreciation caused our targeted 3% equity overweight to grow to 5.26%, so our rebalancing effectively locks in that profit.
Stocks experienced a healthy 8% correction from June 8 through June 15 but have retraced 6% of that through yesterday. Given the market’s growing concerns about a spike in infections in several key southern states, shifting political fortunes ahead of the presidential election and difficult upcoming reports on second-quarter GDP growth and corporate profits in July, we think it prudent to reduce our equity allocation. Collectively, these issues could trigger additional near-term consolidation in stock prices of about 10% in coming weeks.
Spike in coronavirus infections Several key states, including Florida, Texas, Arizona and California, have seen a spike in Covid-19 infections (but not deaths) over the past month. Investors are understandably concerned, absent reliable information. Did these state reopen too quickly or drop the requirements for protection too early? We’re testing more aggressively now, so is the spike in infections simply knowing that some young and previously asymptomatic persons are sick? Did the protests in the wake of George Floyd’s tragic death inadvertently spread the virus? While the heaviest concentration of infections in these states are centered in nursing homes, prisons, meat-packing plants and Native American reservations, are the remaining state trends comparable to national levels?
Trump’s re-election odds plunge President Trump couldn’t possibly have handled George Floyd’s death and the resulting protests any worse, and his poll numbers have plummeted. The odds of Joe Biden winning the presidency in November, along with a potential Democratic sweep, have risen. Investors fear that consolidated Democratic control of Washington will usher in a decidedly less market-friendly fiscal policy regime. That could include higher corporate and personal tax rates; increased Social Security benefits and the elimination of the cap on income taxes for it; higher taxes on capital gains and dividends; and a doubling of the minimum wage. This could result in slower economic and corporate profit growth and lower stock prices.
Tough second-quarter results on tap With the U.S. economy shut down for the first two months of the second quarter, the upcoming readings next month on GDP and corporate profits will be dreadful. We’re estimating a second-quarter GDP decline of 27.8% and think corporate earnings in that quarter could fall 45% year-over-year. If businesses and consumers believe the dreaded second wave of Covid-19 infections has arrived, and they’re also bracing for a barrage of market-unfriendly fiscal policies next year, then the recession we thought would end by midyear could extend into the second half of 2020 and beyond.
As a result, the PRISM® Asset Allocation Committee made the following changes:
Equity Reduced the 3% overweight to a 2% overweight:
- Domestic Large Cap Growth, which rallied 48% since March 23, was reduced from a 2% overweight to a 1% overweight.
- Domestic Large Cap Value, which increased 35% since March 23, was reduced from a neutral weight to a 1% underweight.
- International Developed, which rose 37% since March 23, was increased from a 2% underweight to a 1% underweight.
Fixed Income Maintained a 4% underweight, but with two allocation shifts:
- Government/agencies were reduced from a 2% underweight to a 3% underweight.
- International Fixed Income was increased from a 1% underweight to a neutral weight.
Alternatives Unchanged at a neutral allocation.
Cash Increased from a 1% overweight to a 2% overweight, to build dry powder to be redeployed into stocks at more attractive valuation levels.
Bond duration target Remains at 100% of benchmark.