Parsing the Correction – September 25, 2020

Parsing the Correction – September 25, 2020
Morgan Lewis Posted on September 25, 2020

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Parsing the Correction

The markets have entered a corrective phase as they look ahead. Uncertainty looms around the ability to move forward with a fiscal stimulus package, as well as election outcomes and vaccine news. Fed Chairman Jerome Powell, during remarks in front of Congress this week, urged cooperation in putting forward additional fiscal stimulus and to end the partisan stalemate. He may well be signaling recognition that monetary policy is already quite loose, and that Fed balance sheet expansion may have its limitations. 

In terms of the elections, although the polls as well as betting odds indicate that Biden is likely to win, we would be quick to point out that the polls showing that Hillary Clinton would win handily were clearly wrong. Additionally, polls can change rapidly. This coming week we will have the first debate between the two candidates, which will possibly be a game changer. Meanwhile, the markets churn as they digest the uncertainty ahead. 

Precious metals did not escape the market churn. Gold was down 4.4 percent for the week. The stocks fared less well, despite commentary from companies at industry conferences to the effect that they are squarely focused on returns to shareholders rather than growth for growth’s sake. The HUI Amex Gold BUGS Index was off 8.3 percent for the week, and the Junior Gold Miners index was off 11.1 percent. Faring worse than the stocks, silver was off 15.6 percent as momentum investors hit the exits. Platinum was off 9.2 percent. 

Year-to-date, precious metals have performed well. Long term, we believe that this is an asset class that can provide both offense and defense to a portfolio given its uncorrelated nature over long periods of time. However, we are keenly aware that the markets tend to focus on events at the margin. A second derivative effect, or the slowing of the rate of change of the growth of the Fed balance sheet (rather than expansion in absolute terms), may very well be at work in the short run.

Broader natural resources did not fare well, either. The S&P Global Natural Resources Index was off 6.7 percent for the week. Crude was off 2.4 percent, copper off 3.5 percent, nickel off 5.4 percent, and iron ore off 3.5 percent. Natural gas was the lone standout, up 4.8 percent due to low inventories and declining production of natural gas associated with oil production, and expectations of unseasonably cool weather in North America. Lumber was up 1.7 percent on continued tailwinds around homebuilding activity. We saw a statistic this week that the cost to build a single-family residence is up 17 percent year over year nationally, and this is largely due to the meteoric rise in lumber prices. However, we are hearing that orders from big box retailers have begun to slow, and believe caution in this area is warranted in the near term. 

REITs had a challenging week as well. The Dow Jones Equity REIT Total Return Index was off 4.4 percent, although property types more insulated from COVID and the economic downturn fared better than those that are heavily impacted. The Bloomberg REIT Regional Mall Index was off 11.1 percent, and the Bloomberg REIT shopping center index was off 11.4 percent. The Bloomberg Hotel REIT index was off 9.7 percent. The longer the COVID crisis drags on, the greater the likelihood is that many of these properties, despite being investment grade Class A properties, may be impaired from a valuation standpoint. We watch this area with keen interest as a significant sell-off in the sector at large may present opportunities in areas and companies that are of interest to us.

Infrastructure was decidedly a mixed bag. The US Infrastructure ETF was off 4 percent. On one hand, defensive utilities were a standout. The Dow Jones Utilities Index was only off 24 basis points for the week. On the other hand, the Alerian MLP Index, measuring the performance of energy infrastructure, was off 9.4 percent. We think there is compelling value in both areas, but recognize that energy infrastructure may continue to see multiple compression until the economy can recover, despite in some cases having very similar fundamental characteristics to utilities. 

Given how far and fast the markets have come off of the COVID lows, and given how frothy valuations have become, a correction is to be expected. It’s a healthy and even welcome development, albeit a painful one, particularly for those who chased momentum on the way up. Given the fact that the NASDAQ is up 70 percent off of the March lows, we must remind ourselves that trees do not grow to the sky. 

Our pencils are always sharp.

Best Regards,

David McAlvany
Chief Executive Officer



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