Third Quarter Newsletter
Responsible Guidance: Third Quarter 2020 Newsletter, October 2020
A Risk by Any Other Name
Phew…Third quarter of 2020 is behind us. As you will see from the information in our newsletter, though equity markets have had a nice rebound over the last two quarters, the economic picture remains unclear. Coming into September, that lack of clarity started to have an impact on the equity markets, as investors looked to the fourth quarter with potential risks related to the need for more stimulus, risks surrounding the actual election itself, as well as the possible results, and both economic and human impacts from the Coronavirus.
There will always be potential risks in investing. If there was not, there would be no potential for reward. As you go through different economic and market cycles, you may hear comments from time to time like "…it's different this time…" Though feelings or emotions may be different, as far as Your Personal EconomySM goes, it is not different. Regardless of the risk name - stimulus, virus, election, economy, etc. - it is the results that ultimately matter. At any time, the market can go down or up 5%, 10%, 15% etc. (understanding there are short-term trading halts in place to help prevent immediate and drastic sell-offs). Trying to predict these moves over weeks, months, 1 year, 5 years, 10 years and even multiple decades is statistically very difficult, if not impossible. We think it would be very difficult to find someone who not only forecasted the largest move down in equities for a one-month time period in March of 2020 but also predicted equities would then turnaround and have two strong quarters in a row.
Instead of trying to guess the specific scenario and effect of what happens next, think more about how market moves, both up and down, may impact your lifestyle. We call this determining your ability to take risk. Determining and understanding your ability to take risk helps you position yourself and Your Personal EconomySM for multiple financial outcomes, which we believe will help you sleep better at night, regardless of the exact risk name.
A Global Perspective
A core objective for our customized Baron Financial Group investment strategies is global diversification. Global diversification means including investments based both domestically in the U.S., as well as internationally in developed and developing countries.
There are popular benchmark indexes that provide perspectives about performance of global investments. For equities, we monitor the MSCI ACWI All Cap Index. This index is designed to represent equity investments across 23 developed and 24 emerging markets. The index was up 8.13% in the third quarter, as equity performance continued to rebound from the downturn most experienced in March, due to the impacts from the Covid-19 pandemic. Year-to-Date (YTD) the index finished in positive territory, just barely, up 0.47%. For fixed income, or bonds, we track the FTSE World Government Bond Index. The index tracks sovereign debt from 20 countries, denominated in their respective currencies. It was up 2.94% in the third quarter and performance is positive for the year, so far, at 7.14% as high-quality fixed income investments have performed better than many equity indexes across the globe.
As we review the most recent economic data available, it is difficult to point to any specific overall direction for the economy. There continues to be a mixed bag, so to speak, of information.
The Bureau of Economic Analysis (BEA) announced in its third estimate for the second quarter of 2020 that real Gross Domestic Product (GDP) decreased 31.4%. We believe it is obvious that the shift to negative growth was a result of the government issuing stay-at-home orders and shutting down economies in response to the spread of Covid-19.
The BEA did release a technical note related to second quarter GDP, which can be found on their website at www.bea.gov. An excerpt from the technical note stated "…The decline in second quarter GDP reflected the response to COVID-19, as “stay-at-home” orders issued in March and April were partially lifted in some areas of the country in May and June, and government pandemic assistance payments were distributed to households and businesses. This led to rapid shifts in activity, as businesses and schools continued remote work and consumers and businesses canceled, restricted, or redirected their spending."
GDP is a measurement of what has already happened. There are, however, statistical measures that give insight into the future. One of those measures is The Conference Board Leading Economic Index® (LEI) for the U.S. The index is an analytical tool that helps signal peaks and troughs in the business cycle. The August LEI, released on September 18th, improved to 106.5 (2016 = 100), following increased readings in June and July.
“While the US LEI increased again in August, the slowing pace of improvement suggests that this summer’s economic rebound may be losing steam heading into the final stretch of 2020.”, said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “Despite the improvement, the LEI remains in recession territory, still 4.7 percent below its February level. Weakening in new orders for capital goods, residential construction, consumers’ outlook, and financial conditions point to increasing downside risks to the economic recovery. Looking ahead to 2021, the LEI suggests that the US economy will start the new year under substantially weakened economic conditions.”
We first shared the following chart in our 2018 fourth-quarter letter and believe it is important to continue to track as a potential recession indicator. The blue line represents the LEI, dating back to the year 2000. Since then, we have had two official recessions, which are identified by the shaded gray areas. A recession is typically defined as two consecutive quarters of negative economic growth. Using the last two recessions as a gauge, we believe that the chart suggests that there was significant erosion in the LEI (blue line moved lower) prior to the economy going into recession. Of course, in 2020, the shutting down of economies to help slow the spread of the virus lead to violent changes in economic numbers. Though we have not yet had 2 quarters of negative growth, we think it is safe to say the U.S. has been thrown into a recession. There has been a quick rebound, but we will have to see if the momentum will continue. Clearly the comments from Ozyildirim suggest challenges are ahead.
The full release from the Conference Board can be found at: https://www.conference-board.org/pdf_free/press/US%20LEI%20PRESS%20RELEASE%20-%20September%202020.pdf
According to the Bureau of Labor Statistics (BLS), the U.S. added 661,000 jobs for the month of September and the unemployment rate moved down to 7.9%. The biggest gains in September were in leisure and hospitality, retail, health care and social assistance, and professional and business services.
The Conference Board Consumer Confidence Index® increased in September to 101.8 (1985 = 100). This came after a decline in August.
“Consumer Confidence increased sharply in September, after back-to-back monthly declines, but remains below pre-pandemic levels,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “A more favorable view of current business and labor market conditions, coupled with renewed optimism about the short-term outlook, helped spur this month’s rebound in confidence. Consumers also expressed greater optimism about their short-term financial prospects, which may help keep spending from slowing further in the months ahead.”
The S&P 500, an index consisting of 500 of the largest U.S. domestic stocks, was up 8.93% in the third quarter, and was able to move back into positive territory for the year, up 5.57%. For technical analysts and trend followers, the index remains above its 200-day moving average. Something worth mentioning is that the continued strong performance by technology companies means their influence continues to grow on market-cap-weighted indexes, like the S&P 500.
International developed country equities (such as those in the European Union), measured by the MSCI EAFE index was up 4.80% in the third quarter, however, year-to-date performance remains negative, down 7.09%. Non-developed, or emerging countries (such as China, India, Brazil or Russia) measured by the MSCI EM index, was one of the better performers in the third quarter, up 9.56% but, as with most equity benchmarks, it is down 1.16% so far for 2020.
U.S. Domestic Fixed Income (bonds), as measured by the Barclays U.S. Aggregate Bond Index, produced a positive 0.62% return in the third quarter, driving 2020 performance to 6.79%.
The 10-year U.S. Treasury bond yield was 0.69% at the end of the third quarter, which is lower in yield than where it began the year at 1.88%.
The Federal Reserve (Fed) cut short-term rates to basically 0% once the seriousness of the pandemic set in, and investors continued to buy longer-dated Treasury investments driving those rates lower.
If you plot interest rates versus the time-to-maturity to earn those rates, you have created what we call a yield curve. In previous newsletters we have written in detail about the changing shape of the yield curve and what that may signal. Specifically, we follow the shape of the yield curve (plot of interest rates for different time periods). Using the U.S. Government 2-year bond rate as a proxy for short-term rates and the 10-year U.S. Government Bond rate as a proxy for long-term rates, we calculate the difference between the rates, which provides a possible indicator for the future direction of the economy. A steep spread (long-term rates higher than short-term rates) indicates possible future economic expansion and fixed-income investors are compensated for taking longer-term risk. A flat spread (long-term rates match short-term rates) is a possible indicator of economic uncertainty and longer-term investors are not being compensated for investing in longer-dated securities. An inverted spread (short-term rates are higher than long-term rates) possibly indicates future economic contraction.
The third quarter finished with the 2-year rate at 0.13% and the 10-year at 0.69%. Technically speaking, that suggests an upward sloping or steep curve. The 56-basis point spread (a basis point represents 1/100 of 1%) is larger than where the year began, as well as at the end of the second quarter. Though steeper, we think it is safe to say that the bond market continues to be uncertain about the future of the economy. The changing shape of the yield curve has really been occurring since at least 2014, when the spread between the 2-year and 10-year was over 220 basis points (bp).
Housing and Real Estate
Commercial real estate, as measured by the FTSE NAREIT All Equity REIT (Real Estate Investment Trust) Index was up slightly in the third quarter at 1.19%. The index remains down 12.27% on the year. Our investment committee at Baron continues to review challenges and opportunities for these investments. We hear opportunities are potentially increasing for areas related to tech, such as data centers and cell towers, self-storage, and healthcare, to name a few. While potential challenges and concerns remain for traditional office space, retail space and senior housing.
According to Freddie Mac (FM), the average 30-year residential home mortgage rate is at or near all-time lows at 2.88%. The rate was 4.51% (close to a seven-year high) near the start of 2019. The lower rates may continue to have a positive impact on the housing market. For those who have a current mortgage and have not refinanced in some time, it may be worth looking at potential options.
The Bloomberg Commodity Index (BCOM) increased in the third quarter, gaining 9.07%, however, year-to-date performance remained weak at negative 12.08%. Though the index had a solid quarter, the overall slowdown in the economy and lack of demand for traditional natural resources and energy continue to create challenges for this asset class.
Baron Client Strategies
This has probably been one of the most active investing years for us at Baron. As clients know, we are fiduciaries and operate as fee-only advisors, so there is no benefit to us for making investment transactions. The reason we make trades is because we believe the actions are potentially strengthening the client's portfolio or financial position. We use the same approach with our own personal money.
No matter the economic environment, our basic principles remain:
Create a globally-diversified and risk-appropriate strategy. Validate the investment choices versus peer investments. Rebalance when needed. Test the strategy in a comprehensive financial plan and obtain regular feedback to update information and advance your financial position.
Your Service PlanOne of our primary roles is to educate our clients to make informed decisions about reaching their goals. Critical to that process are plan reviews, a process that focuses our attention on your goals, takes account of any changes in your situation and allows us to alter the course, as necessary.
For more specifics, check out our “What You Can Expect” document by clicking the button below.
Your Personal EconomySM
You may have heard us say that we are happy to help clients with issues outside of investing that may have an impact on their financial lives. We say things like “Lean on us when you are making a decision with anything with a dollar sign involved.” So, we have been including this section as a reminder of all of our services and to share ways in which we have helped clients outside of investing.
If you are near or in retirement, the type of resources and the way you use those resources to pay for your lifestyle will most likely be changing. At Baron Financial Group, we help our clients create a Paycheck SystemSM that considers personal situations, taxes, and other items to structure a plan to help optimize the use of your resources. With the proper planning, well in advance of retiring, we can help make your financial resources look like you are still working, without having to actually work. Talk with us to determine the value of your resources and how your Paycheck SystemSM may work in Your Personal EconomySM.
Regardless of the risk name - stimulus, virus, election, economy, etc. - we believe it is prudent to plan Your Personal EconomySM around multiple scenarios, not just a single possible outcome. We know that going through this process will help you best understand your ability to take risk with investments and allow you to position Your Personal EconomySM in a way that is best for you.
Because meeting in-person is not as easy as it used to be, we continue to suggest clients consider a video meeting if you have not done so already. You do not have to be on camera, but we can be, and we can share our screens to help review reports and other information.
Without in-person meetings we have been creating more video content to help keep you informed and maintain a connection with your Baron Team. Hopefully, you have seen our video thanking the Healthcare workers and sharing some great photos of the Baron Team working from home. We have shared other videos recently (some will launch soon), instructing use of our Baron Portal, explaining cybersecurity and ways we protect client identity and data, answering questions about Your Personal EconomySM, and reviewing recent market performances.
October is Cybersecurity Awareness Month. We hope you found our educational cybersecurity videos helpful. Please let us know if you would like our complimentary guide on fraud prevention and how to respond to a data breach.
We look forward to sharing additional educational, as well as fun videos throughout the year. Keep a look-out for these on the small screen and let us know what you think.
Remember that you can visit our website to gain access to your client portal. Just click on the client-portal tab, which will allow you access to view your account information. The client login requires a username and password to gain access through the portal. Please let us know if you would like to create your portal login or if you would like to learn more about what the portal provides.
Would you like to enroll in paperless Baron statements? Paperless statements will be accessible through our online client portal in the “Documents” section. You must be enrolled in the client portal to view your paperless statements. You will receive an email notification each quarter your statements are posted. Contact Baron at 1-866-333-6659 or at firstname.lastname@example.org to enroll.
For more educational content, please visit our Website Blog. The Baron Advisors are often called upon by journalists for their insights on financial planning and investing. They are quoted in such prestigious media outlets as The New York Times, CNBC.com, and NJMoneyHelp.com, among others.
Are you approaching or already Medicare age? For those 65 or older, registering for Medicare can be confusing and stressful. Remember you are not alone in making this decision. Lean on Baron as a resource to help with the decision-making. We invite our clients to work with a Medicare expert to make sure both coverage and costs are optimized. Remember, the program is not a set it and forget it plan. Reviewing annually is very important, so make sure you are using your Baron resources to the fullest. The period for Medicare’s Annual Enrollment for 2021 coverage runs from October 15, 2020 through December 7, 2020.
We are proud of our philanthropic efforts, which include pro-bono work, as well as monetary donations to The Fair Lawn Food Pantry, the All Faiths Food Bank in Sarasota, the Adopt-A-Soldier Platoon, Spectrum for Living (serving adults with developmental disabilities) and the SCARC Foundation Capital Campaign (serving people with developmental disabilities). In addition, we are proud to continue our ten-year tradition of providing a Baron Financial Group Scholarship to two deserving Fair Lawn High School graduates (1 female and 1 male), who plan to further their business education. We are happy to help!
Unfortunately, we are not able to hold our usual holiday celebrations this year, due to the pandemic. However, we are working on something electronically and will be excited to share our Holiday messages with you. We hope we will be able to resume our special events next year and see you soon! We miss seeing you in person!
Baron Financial Group, LLC
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 5, 2020 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Baron Financial Group to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client or prospective client’s investment portfolio. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. Inclusion of index information is not intended to suggest that its performance is equivalent or similar to that of the historical investments whose returns are presented or that investment with our firm is an absolute alternative to investments in the index (if such investment were possible). Investors should be aware that the referenced benchmark funds may have a different composition, volatility, risk, investment philosophy, holding times, and/or other investment-related factors that may affect the benchmark funds’ ultimate performance results. Therefore, an investor’s individual results may vary significantly from the benchmark’s performance.