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Light at the End of the Tunnel: Proceed with Caution

S Rossi 2014
Stephen A. Rossi, MBA, CFA®, CFP®, ChFC®
Senior Vice President, Senior Equity Strategist
[email protected]
(585) 419-0670 x50677

Published on December 4, 2020 in the Rochester Business Journal

After falling to a March 23rd low of 18,592 this year, the Dow Jones Industrial Average (Dow) rallied to 29,950 on November 16th – an increase of over 61%. Some of this was due to positive results for a number of new COVID vaccine candidates, the civil passing of Election Day on November 3rd, and a 15-country Asia-Pacific trade agreement signed on November 15th. Despite the recent exuberance, however, one would be wise to maintain a cautious disposition in their investment portfolios. Fallout from a resurgence of the COVID virus, weakness in certain economic data, and structural issues related to entitlement programs like Medicare and Social Security are just a few areas to be leery of.

The month of November saw successful results for the late stage testing of COVID vaccines from Pfizer, Moderna, and AstraZeneca. The Pfizer and Moderna candidates were shown to be 95% effective, while Astrazeneca’s candidate was proven to be 62% to 90% effective, depending on dosage regimen. On each day the data was released, the Dow closed meaningfully higher, as hope and optimism about overcoming the coronavirus became increasingly more pervasive.

Joe Biden’s apparent win on Election Day, especially without incident of civil unrest, was another event that the financial markets seemed to revel in. This was perhaps a bit unexpected, in as much as promises to increase taxes on the wealthy don’t typically resonate well with investors. Apparently, though, Republican retention of the Senate and big gains in the House, make it difficult to implement big changes that are not bi-partisan. Market’s often like gridlock when it prevents major policy changes that can be costly to the economy (i.e. taxes, Green New Deal, etc.). Here, again, the market traded higher on the day before, the day of, and on each of the next two days after the November 3rd election.

The Regional Comprehensive Economic Partnership (RCEP) was signed by 15 Asia-Pacific nations on November 15th, including China, Japan, South Korea, Australia, New Zealand, Thailand, Vietnam, Singapore, and Malaysia, among others. The partnership will reduce tariffs and promote free trade in the region but, most notably, it will not include the U.S., the European Union, or India - at least initially. Pundits from the Peterson Institute for International Economics and John Hopkins University suggest that Japan and South Korea stand to gain the most from the Partnership. As major U.S. trading partners, real incomes in these countries are expected to be 1% higher than they would have otherwise been by 2030. This added fuel to the market’s gain after the agreement was signed which, coincidentally, was the same day that the favorable Moderna Pharmaceuticals results were released.

Despite the favorable events mentioned above, social, political and economic challenges remain. As people have let their guards down and refused to adhere to masking and social distancing protocols, COVID infection rates are again soaring, and many parts of the Country are returning to yellow, orange, and even red states of emergency. It’ll be months before the above-mentioned vaccine candidates can be approved, produced commercially and administered to reach critical mass, and there’s real potential for a return to a partial or full shut-down of all non-essential services in the meantime. This would obviously have a detrimental effect on the market, particularly since valuations are stretched well above their historical averages in just about every geographic area or economic sector for which data is available.

The corollary to concerns about a COVID resurgence include the economic fallout that can and will continue as a result. Industrial production is still contracting, there were 778,000 new claims for jobless benefits for the week ending November 21st - leaving the unemployment rate at nearly twice what it was in February - consumer confidence is meaningfully lower than it was a year ago, and our national debt and deficits are rising.

As if the economic data mentioned above wasn’t cause for concern, the Congressional Budget Office (CBO) now predicts that Medicare will become insolvent by 2024 (i.e. two years earlier than initially projected), that the Social Security Disability (SSD) program will become insolvent by 2026, and that the Social Security Income (SSI) program will become insolvent by 2031. This could put additional pressure on the financial markets, prompting benefit cuts, higher taxes, more Government borrowing, or a combination of the three, unless another viable solution can be found. Accordingly, investable assets may be exposed to a correction.

We should all be thankful that the financial markets have performed as well as they have this year, and I’m sure everyone is eager to put the current pandemic behind us. Hope and optimism in working toward that end are what unite us and keep us moving forward. Just keep in mind that the market may be a bit ahead of itself as price relates to earnings, and that rebalancing recent gains in your portfolio may be a prudent idea. In this context, there’s nothing wrong with reveling in and chasing the proverbial light at the end of the tunnel. Just make sure you take the appropriate precautions in your investment portfolio, so you don’t inadvertently run into oncoming traffic.

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