Quarterly Commentary: 2020 Fourth Quarter

Market Themes

As we enter the home stretch of election season in the United States, Democratic nominee Joe Biden looks to have an edge in the race. We see three plausible scenarios to plan for:

A Democratic sweep of the White House and Congress (with Democrats winning control of the Senate);
A Biden win with a divided Congress; and
A status quo Trump win.

The COVID-19 pandemic has helped create historically challenging circumstances for the election, including a leap in mail-in voting, which adds complexity and increases the probability of legal challenges. A contested election could delay a definitive outcome for weeks or months.

With this increasing uncertainty potentially driving up market volatility, we are being careful with the risk in the portfolios especially with some of the momentum growth stocks.

Our strategy from earlier in the year called for rising stock prices supported by improving COVID-19 abatement efforts, easing of economic lockdowns and an ultra-accommodative Federal Reserve. Our tilts to technology and large-cap stocks have led the way so far in the early recovery — but some of our more tactical bets on cyclically-oriented stocks have been slower to payoff.

Nonetheless, despite the election risks, we maintain our view of a broader economic recovery, so continue to overweight stocks and hold positions in both large-cap/growth and small-cap/value stocks.

China has been leading the economic rebound in global output, with other emerging economies across Asia on similar paths to robust recoveries. If improving economic data trends continue, then the case for emerging market equities becomes stronger. Conversely, we have seen a lukewarm recovery and weaker earnings estimates in Europe.

Portfolio Changes Since Last Quarter

Overall Asset Allocation

Trade Rationale

While we don’t see a Biden or Trump presidency with a divided Congress as a decidedly risk-off event, we believe it’s prudent to reduce risk in case potentially more adverse outcomes materialize.
The portfolios increase exposure to higher-quality large cap stocks and reduce exposure to more volatile small cap stocks, bolstering overall resilience to potential election and COVID-19 related shocks.
We are reducing exposure to the financial services stocks. The Fed’s has communicated an ultra-dovish stance in forward guidance and average inflation predictions
Short duration credit positions are reduced to help fund a position in mortgage-backed securities, with the goal of further insulating portfolios from a risk-off event.

Portfolio Performance

US stocks swelled to fresh record highs over the course of the summer, emboldened by improving employment numbers, a better-than-expected corporate earnings season and promising COVID-19 vaccine trials. However, volatility spiked in September, with US election anxiety, a potential second wave of the virus in Europe, and elevated valuations spooking investors.

The well-publicized outperformance of growth versus value continued over most of the third quarter before suddenly reversing in the final weeks, with many of the YTD work-from-home winners getting especially punished amidst a broader market sell-off.

Regionally, US and Emerging Market stocks led the way, boosted by fiscal stimulus expectations and the rapid recovery seen in China. International stocks lagged, as lackluster corporate earnings and renewed Brexit concerns sullied investor risk appetite. US treasuries served as a stabilizer to the roller coaster ride in equities, with yields ending the quarter nearly unchanged.

US large cap, growth-oriented International stocks and Emerging Market stocks were the largest contributors to return, followed closely by US medical device stocks. Global technology stocks continued to pay off.

Asset Class Views

Asset Class	Views	Rationale
Asset Allocation
Equities vs. Fixed Income		We maintain an overweight to equities, but less so than last quarter, amidst US election uncertainty. Nonetheless, we still find equities broadly attractive based on forward-looking earnings estimates, continued fiscal and monetary stimulus, still attractive risk premiums, and re-opening economies.
Equity
U.S. Equities		We maintain an overweight to U.S. equities. We reduced our tactical bet on financial services stocks based on an increasingly dovish Federal Reserve. We maintain strategic allocations to technology, medical devices, and small cap/value stocks.
International Equities		We increase our underweight to the International equities market, seeing limited opportunity for relative upside due to a lukewarm economic recovery and weaker revisions to earnings estimates across Europe. Further, sluggish trade activity, a resurgence in Covid-19 cases, and the return of Brexit uncertainties compound an already unattractive risk/reward profile.
Emerging Market Equities		We move to overweight emerging market equities, based on improving economic data trends in China and other emerging economies across Asia. Latin American countries continue to struggle with containing the spread of Covid-19 but strengthening demand from China for local commodities has helped mitigate lingering economic weakness, especially in Brazil.
Smart Beta		The potential benefits of smart beta remain tied to their diversification potential, and our tactical view is that the value and minimum volatility factors are better suited for the current protection strategy.
Fixed Income
U.S. Treasuries		We believe Treasuries can continue to serve as a source of diversification vs. equity and credit risks and should help insulate the portfolios from potential US election or Covid-19 shocks.
U.S. Investment Grade Bonds		We trim exposure to fixed income, most prominently to shorter-term issues, but maintain our overweight call, recognizing that purchases from the Federal Reserve continue to provide support.
High Yield Credit		We hold some high yield bonds to capture a potential recovery as economies continue to re-open.
Emerging Market Bonds (USD)		We maintain a small strategic position due to the potential yields the asset class offers.