In the third act of Shakespeare’s seminal play, King Henry V utters, “Once more unto the breach, dear friends, once more.” The words are intended to motivate the king’s troops amid continuous assaults on the gaps of the city walls during the siege of Harfleur. The motivation was necessary, as the weary English forces were beaten back and unsure about their prospects for victory. To forge ahead, courage and steely resolve were essential.
With the standard 60/40 portfolio sitting on current year-to-date gains against a backdrop of an elevated risk regime,1 investors may need to find a similar steely resolve today. As summer turns to fall, global capital markets face five key risks:
The pandemic – COVID-19 cases continue to rise around the world, albeit more slowly, creating confusion and delaying any return to normalcy. In many parts of the world, the weather is starting to turn colder, and the pandemic will converge with flu season. However, not all pandemic risks are to the downside: There have been encouraging advances with regard to a potential vaccine and more robust testing.
The re-opening of schools – Whether online-only, hybrid, or in-person, back-to-school season amid the pandemic will be inherently disruptive, confusing, and lead to an array of potential risks. Pitfalls in this new abnormal range from increased case rates as people congregate more regularly to heightened stress and potential lack of productivity for parents juggling work while ensuring their children are able to learn.
Earnings season without the low bar – Sizeable second-quarter earnings surprises fueled gains over the last few months. In the S&P 500® Index, 84% of firms surprised to the upside by a magnitude of 23%,2 both record figures. The eye-popping results were made possible by a low bar: Second-quarter estimates were slashed 37%,3 also a record. Third-quarter earnings season is unlikely to have the same low bar, as estimates have actually improved by 3 percentage points since June.4 While still projecting a decline, without a vastly lowered bar and more data on post-pandemic operations, the price reaction from earnings season may not be the same. This environment isn’t confined to the US: Global earnings estimates haven’t been slashed to the same degree seen for the second quarter.5
Elevated valuations – US stocks have not been this richly valued since the dot-com era, and by some metrics (e.g., next twelve-month price-to-earnings ratio), stocks are trading at higher valuations than during the dot-com era.6 Overseas, valuations are more constructive; however, considering that US equities make up more than 50% of global benchmarks,7 the nosebleed multiples do not portend a great margin of safety if investors no longer wish to pay more than $26 for next year’s earnings.
The election – For the rest of 2020, the US election is the proverbial elephant (and donkey) in the room. Over the next few weeks, rhetoric will intensify as heightened social unrest can no longer be separated from any election discussion. During September, the election will likely produce more noise than actionable news. Following the debates, more tangible information about candidate platforms and polling behavior will become available. Typically, autumn seasons with elections are more volatile than non-election autumns, a trend likely to continue given the unorthodox nature of this election cycle.
Asset class ETF flows: Bond funds still gaining, though record streak ends For bond ETFs, the four-month streak of $20+ billion monthly inflows ended in August. As shown below, the asset class only took in $16 billion last month. Sizeable outflows from government funds dragged the segment lower, partially offsetting the strength in all other areas. Notably, the $16 billion figure is still above the five-year median for monthly flows of $10.5 billion.
Equity ETF flows remained somewhat constrained in August, even as the broader market rallied back to new all-time highs . The $17.3 billion inflow in August is below the five-year median figure of $20 billion. Flows into commodity funds continued to shine, led by precious metal exposures, including gold. In fact, while bond ETFs saw an end to their record streak, gold funds’ streak of more than $1 billion of monthly inflows continued in August. With an inflow of more than $2 billion last month, the record now stands at eight consecutive months.