Market Insights

In the past two weeks, investors got a lot more clarity on two of the largest clouds hanging over the market: the U.S. election and the coronavirus.

We now know who the next president is, and have a better idea (Georgia’s Senate election notwithstanding) of what the balance of power will look like in Washington D.C. And news that Pfizer’s coronavirus vaccine has shown a high success rate offers hope that we may be on the path toward addressing the coronavirus pandemic and normalizing the economy, even if current infection spread is alarming.

In this brief Q&A, Dana portfolio managers Joseph Veranth and David Weinstein reflect on what the election and vaccine could mean for markets going forward

Large cap stocks have outperformed small caps since the pandemic, but smaller stocks have begun to close that gap in recent weeks. It’s still early, but if investors stay patient, we believe small caps could be poised to continue to outperform in the coming quarters.

This blog post explores what was behind small cap underperformance in prior months, and why smaller stocks may outperform going forward, particularly when we receive clearer indicators of an economic rebound.

In Initial Months of Pandemic, Mega Caps Enjoyed Mega Dominance

Large caps’ outperformance over small caps in the spring and summer was due largely to the very largest stocks in the indices, a trend we noted in prior blogs. Many of the largest companies by market cap are tech stocks, and their revenue streams were naturally resistant to the pandemic and a stay-at-home lifestyle. Individuals still need Microsoft to work from home, for example, and relied on Amazon for delivery more than ever before.

Mergers and Acquisitions (M&A) activity among asset management firms is creating some investment behemoths. As these businesses scale up, we hope their clients are asking a critical question: What’s in it for me?

The consolidation wave running through the industry continued this month, with Morgan Stanley announcing it will acquire Eaton Vance, and Trian taking stakes in two large asset managers with the hopes they will merge. The announcements follow several other mega-deals in the past few years.

Too often, the touted benefits of these mergers seem focused on two factors: size and scale. But does bigger mean better for the client? As a small investment boutique, we admit we approach this argument with our own bias, but we see a few reasons clients may not benefit when their investment partners merge.

The presidential race may be polarizing, but both sides can agree on one thing: It at least has been compelling. The unexpected twists and turns over the past month have everyone anxiously awaiting November.

We’re anxious too. But as investors, we don’t just think about who we want to win. We try to think about what could happen in a range of different – and unexpected – outcomes. In this brief Q&A, we look at some of the factors investors should consider before November. The views are not a wish list of a particular election outcome or an endorsement of a party or candidate, just straight-forward things that advisors and other investors should think about:

What is the base case markets are pricing in about elections right now?

Markets, like polls, are predicting a win for Joe Biden. The general view is that he would be less business-friendly and that this could ultimately weigh on corporate profits. However, it’s likely that Republicans could still control the Senate.

It’s generally believed Republicans will pick up a Senate seat in Alabama. If that happens, Democrats would need to flip three seats to get to 50/50. The most likely are Maine, North Carolina, Iowa, Colorado and Arizona. We believe the market is currently hanging its hat on a Biden win, but that flipping three of those five would be a tall order.

Stocks recovered some ground last week, but September was the roughest month for U.S. equities since stocks began rebounding from bear market territory in late March. Below are a few quick takeaways on the September swoon, what may lie ahead, and how we are investing:

• Given the disconnect between Wall Street and Main Street, a correction wasn’t entirely surprising. In the spring, the question clients asked us most frequently was why stocks continued to drive higher, despite high unemployment and a clear downturn in economic activity.
  
  The short answer was that fiscal and monetary stimulus boosted markets and gave hope that the economy would rebound quickly. In September, investors may have woken up to the reality that the economic recovery will be uneven, and economic activity and data will probably move in fits and starts. An impasse in Congress around additional coronavirus relief has raised additional concerns about the economic recovery.

The financial crisis was painful for anyone working on Wall Street, but the period gets credit for improving at least one industry dynamic: The bar for effective communication from an asset manager has been significantly raised.

As markets plummeted, advisors, consultants, investment committees and other key fund decision makers demanded dialogue from their portfolio managers about the market collapse and what they planned to do going forward. The demand for increased communication continues today, and is an industry trend we applaud.

Advisors and consultants deserve shared insight from their investment managers, and an open forum for communication. In short, they deserve true partnership. We believe boutique asset managers are best positioned to deliver the partnership clients deserve.

As investor interest in ESG grows, so too are the number of ESG strategies to choose from. Already, 23 ESG funds have launched in 2020, and more than 20 others are in registration at the SEC, according to Morningstar.¹ This marks the sixth straight year of more than 20 launches.

With more fund launches, due diligence isn’t getting any easier. We believe one way advisors and other allocators can help their clients find the right strategy is to ask whether they want a fund that is directly engaging businesses to improve corporate policy around ESG issues.

Many ESG funds do not engage management teams on policies, but instead rely on ESG ratings to screen out non-ESG friendly companies and include companies with better ratings. That may well be enough for some clients.

With growth stocks on a historical run of outperforming value, many allocators are wondering if mean reversion is due and are questioning their allocations to both style boxes. But growth or value may be the wrong question to ask.

As Dana portfolio managers explained in a recent Q&A on the ways active managers can differentiate their strategies, core strategies may provide optimal exposure. The Q&A also runs through a classic example of the perils of overpaying for growth, and touches on a less discussed benefit of core strategies: tax efficiency. As our portfolio managers explain:

It’s a natural reaction to every bear market. As stocks plummet, clients start wondering whether they should pull money out of equities and wait on the sidelines until conditions improve. If you’re an advisor, you may have had several conversations along these lines recently. We salute your efforts to help clients stay the course.

At Dana, we realize the importance of staying fully invested and reflect it in our investment process, which dictates that funds hold minimal cash. Our view is that it is always better to stay fully invested because not even experts can perfectly time a rebound.

However, we know it can be challenging for advisors to keep their clients invested through a downturn. In the spirit of helping, below are five quick-reference stats and charts we’ve collected that paint a picture of why we believe it’s important to stay in equities through the entire market cycle:

As 2019 ended, the backdrop for the energy sector looked relatively solid. Oil prices were up more than 30% in 2019, and future demand appeared firm, as cooling trade tensions between the U.S. and China led many to believe the economy would improve.

It would have been hard for nearly any expert to predict what would happen next. The coronavirus has severely affected the global economy and, in turn, sapped energy demand. At the same time, a price war between Russia and Saudi Arabia has also driven oil prices lower. As a result, the S&P 500 energy sector is down nearly 52% this year, trailing well behind the next biggest sector laggard – financials – which is down 31%.

On the other hand, heading into 2020 few would have predicted utilities would be the best performing sector, down 13% so far this year, but outperforming others due to its defensive nature.