Gill Capital Partners End of May Update

Now that we are beyond the Memorial Day holiday, summer has officially begun. It may turn out to be one of the most bizarre summers any of us can remember. We know many summer activities and travel plans have been cancelled or significantly altered, but we hope our friends, clients, and partners remain healthy and are able to enjoy the summertime in our new reality. Before heading into the weekend, we wanted to send an overview of this week’s happenings in the world of economics and finance. But first, a bit of humor…

Funny/Interesting Quote/Joke of the Day

Answers to recent survey on how often one needs to change one’s sweatpants while in quarantine:

-Every day - 4.8%

-Every two days - 13.5%

-Nothing matters anymore - 52.8%

-What are pants? - 28.9%

Top of Mind

Countries in the northern hemisphere continue to see improvement with respect to the managing the coronavirus, and reopening continues at a methodical pace. Commensurate with the official start to summer, there is a growing sense of optimism around reopening that continues to overshadow significant weakness in fundamental economic data. This dichotomy continues to drive confusion amongst investors who question the equity rally in light of the economic reality.

Below are a few common questions we receive and our views on them.

Should I be buying stocks right now? While optimism, with help from the Federal Reserve and the U.S. Treasury, has driven stocks materially off their March lows, the value proposition to investors looking to purchase stocks now is not very compelling in the short-term. The chart below is a graphical depiction of the forward P/E (price to earnings) ratio of the S&P 500 Index. This ratio simply tracks the price of the index as compared to estimated future earnings for all the companies in the index. When the ratio is low, as we saw in 2008 or briefly in March of this year, it is a good indication that stocks are relatively undervalued compared to their historical averages. This usually happens because the prices of stocks in the S&P 500 Index value (numerator) have dropped more than the earnings of those companies (denominator). When the ratio is high, as it was in the tech boom of the late 90’s and is again now, it can indicate that the stock market as a whole is overvalued relative to its historical values and anticipated earnings over the next 12 months.

While swings in the P/E ratio matter less to long term buy-and-hold investors, for those attempting to be more tactical and opportunistic, entry point matters greatly. The valuation of the S&P 500 on a relative basis is currently the most expensive it has been since 2001. Earnings expectations continue to be a big question mark, with many analysts believing that current estimates are still overly optimistic. Valuations appear stretched, and for those seeking value or looking for an “entry point,” today’s stock market does not seem to offer compelling value. However, valuations can remain high for long periods of time, and this may be the case in today’s ultra-low interest rate and high liquidity environment.

Why are some segments of the market doing well, while others are struggling? The recent stock market rally has not been an equal opportunity rally. High growth, adaptable tech companies such as Amazon and Apple are at or near all-time high levels, while many value and old-school industrial stocks like energy, financial, and manufacturing companies remain significantly depressed. In fact, the relative outperformance of certain companies in this environment has been stunning. We continue to stress the importance of having active management in portfolios to capitalize on the current environment. Often it is the cyclical stocks, those that are more closely tied to the business cycle (think retail, automotive, housing, etc.), that lead an economic recovery, but we continue to see some of the greatest weakness in these sectors. New economic cycles generally begin with the leaders and laggards of the last cycle switching places, but this time is looking like it may be different. We continue to rebalance portfolios with this thought in mind, as investors have been caught in previous cycles with an overweight to old winners.

With states starting to re-open, does this mean that the correction is over? Optimism and hope have overtaken the pessimism from March as states across the country begin re-opening into an uncertain new reality. We continue to believe that caution is still warranted. The fundamental backdrop (unemployment, spending, manufacturing, etc.) is severely depressed, and the timing and strength of an economic rebound are unclear and heavily dependent on the ability of people to get back to work and return to normal spending habits. While we do not know if the stock market correction is over or if more volatility is to come, there are segments of the economy that are going to struggle to regain their prior strength. Additionally, the possibility of a second wave of infections and the upcoming election loom large as possible sources of future volatility. The direction of the economy depends greatly on the outcome of reopening, our ability to create a vaccine, employment, and whether a second wave of the virus emerges. Each of those items are highly uncertain at this point, so we continue to strike a cautious tone while also recognizing that staying invested over long periods of time has historically produced superior outcomes.

We hope everyone has an excellent weekend and can enjoy the start of the summer season. And please, swap those sweatpants for a pair of shorts, it’s summer, after all…

As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.