Remaining optimistic but incrementally more cautious
Today the Federated Hermes PRISM® committee modestly cut its overweight to equities in its stock-bond model, from 30% of maximum overweight to 20%. While we remain structurally long stocks and the secular bull market, we also believe it is prudent to continue to take profits on our (brave at the time!) call, to hold on at 70% of maximum overweight when we are at market lows. This latest move keeps us overweight, but just less so.
We have three reasons for caution as we enter the back half of 2020:
- Transition from “V” to “U.” This quarter has been all about the very sharp bounce in economic activity and the markets off of rock-bottom levels as Corona news improved, businesses large and small partly reopened, and Americans began to spend some of the cash hoard they’ve accumulated during the forced lockdown when many employment checks and government unemployment benefits flowed in. This was the easy part. Now we will be entering what we have called since early March the coming “U-shaped recovery,” which will have its share of good news, for sure, but also headlines and job losses, associated with companies and industries that find themselves now out of step with the post-Corona world. This process of creative destruction, a hallmark of U.S. economic resilience over the last century, will sow the seeds of the next big economic advance. But in the meantime, there’s a lot of wood to chop and it won’t be all rosy.
- Election concerns will start to loom. Until now, most investors have ignored the fact that a major presidential election is coming this fall, and one that could potentially lead to a dramatic reversal in a number of the pro-growth achievements of the Trump administration. The reason has been that we had an even bigger fish to fry: getting free of the Corona. But now that the country is reopening, we expect the market to begin casting a warier eye on the election ahead. Regardless of your political party, most would agree with us that President Trump’s odds of victory are lower today than they were in February, when the economy was booming and unemployment sat at decades’ lows. There is still a long way to go, but if the president does pull this out, it is likely to be a nail-biter at best in a few key swing states. In addition, in our view, the winner in this kind of election has pretty good odds of carrying the Senate and House with him or her, and that outcome is less expected. Finally, until now, few people have focused on the potential Biden legislative/tax agenda, but when they do, it won’t be good. Bottom line, the uncertainty of the coming election will not be a market positive in the coming months.
- Winners pricey, losers pricey, survivors dicey. Year-to-date, this has been one of the best environments for seasoned stock picking, as evidenced by the performance of several of Federated Hermes’ flagship equity portfolios. As we’ve been signaling for weeks, we think the back half will continue to be such an environment, and more than ever, it will be more about getting the stocks right than getting the market right. That job, as I’ve said, will get harder as we roll through summer into fall. The winners already are pretty fairly priced, and the losers bounced too high in the rally’s “rising tide will lift all boats, even the leaky ones” scenario. That leaves us with the survivors, where we are focusing our incremental portfolio capital. But frankly, the survivors are a dicey lot and some won’t make it. We certainly don’t think there are enough of them to drive the overall market higher if the large-cap growth companies take a breather for the remainder of the year.
For the long term, the bull will continue to run, and we still expect the overall market to make it to our 3,500 milestone on the S&P 500 by sometime in late 2021. But there is a lot of work to be done between here and there. Gotta’ go….