Market Summary

Stocks continued their upward momentum in July and August as Growth stocks helped push the S&P 500 to new all-time highs before correcting in September. Despite the pullback, the S&P 500 returned nearly 9% for the quarter, pushing it into positive territory on the year, and over 50% from the March lows. Once again, Growth Stocks led the market during the quarter, while Value stocks continued to lag [1].

COVID-19 has created a bifurcated stock market with extreme winners and extreme losers across sectors and companies. For example, year-to-date Large Growth was up over 27%, and Large Value was down over 13%, resulting in over a 40% difference just this year [2]. We haven’t seen return differences this lopsided since the late 1990’s when Technology stocks soared.
Like the 1990s, investors today are willing to pay increasingly more for Growth stocks. For example, the chart below illustrates how much investors were willing to pay for Growth and Value companies in terms of Price-to-Book (P/B) – the higher the number, the more an investor is willing to pay [3]. The data ends in March 2020. The valuation difference has only increased through September 2020. By some measures, the difference in valuation has never been wider [4]. As a result, we view Value stocks as having “2nd story risk” and Growth stocks as having “5th story risk”. Growth stocks have gone higher, but if the market wobbles, they may have further to fall.
Over time, we believe, valuations revert to the mean, and we expect meaningful rotation into the underperforming segments of the market. We can’t predict the future, but we could see stock prices in the Value category catch up to Growth companies as the economy continues to recover. We could also see mid-cap and small-cap stocks, which have also lagged the broad market rebound, outperform.
For bonds, it was a quiet quarter the Federal Reserve signaled it would keep interest rates low for an extended period. Riskier sectors of the bond market such as U.S. high-yield bonds and emerging-markets bonds did best. Below is a summary of returns for the quarter [5].
While it is encouraging how quickly the stock market rebounded from first-quarter weakness, there were signs of excess exuberance. Initial public offerings raised more money than at any point outside the tech bubble. High-yield debt is being issued at record low yields, and day traders poured money into speculative companies, increasingly using options [7].
We acknowledge there are pockets of excesses, but we think the rebound is warranted given: 1) the massive stimulus from the federal government and the Federal Reserve ; 2) depressed interest rates that reduce the attractiveness of bonds and enhance the value of future corporate profits; 3) corporate profits on the upswing, and 4) a potential vaccine available within the next 6 to 12 months. We are only months into a new economic expansion and a new bull market. Using history as a guide, both may persist for years [8]. Since 1929, the average bull market has lasted 54 months and gained 166%.

Economic Backdrop

The third quarter was characterized by the carry-over of economic momentum from the second quarter, as states continued to lift restrictions to reopen their economies. Some segments of the economy – notably housing, e-commerce, and auto sales – have experienced a meaningful recovery. In contrast, others such as the labor market, the hospitality industry, and the travel industry have struggled to regain footing, given changing consumer demand patterns [9].

The COVID-19 pandemic has shortened the normal economic cycle. Economic activity suddenly ground to a halt as social behaviors and consumption trends were scaled back dramatically. Given the scale of the economic disruption, monetary and fiscal policymakers responded with measures that stabilized the financial system and provided much-needed relief for lost household and business income. The success of these policy steps, along with better COVID-19 treatment options and adjustments to consumer’s behavior, allowed the economy to begin to reopen reasonably quickly and successfully. Now with a positive outlook for the availability of a COVID-19 vaccine 6 to 12 months away, the global economy is back on track to recovery.

However, the next phase of the recovery will likely be more difficult. The initial recovery phase appears to be mostly over, leaving the economy to transition into a consolidation phase in which the economy grinds ahead on a longer path to recovery. It also leaves the economy more at risk of policy errors and COVID-19 related setbacks. Near-term risks include increases in COVID-19 cases, delay or reduction of another stimulus package, and uncertainty surrounding the U.S. Presidential elections. This is an extraordinarily unusual economic environment. Markets continue to look forward and appear to be pricing in a more durable economic recovery.

U.S. Elections

Historically, stocks have generated positive returns under all political combinations in the White House, House of Representatives, and Senate, including Democratic and Republican sweeps. While this is a significant election, we want to keep any impact on the stock markets in perspective.
Strictly from a market perspective, a potential Democratic sweep of the Senate and presidency could bring higher corporate, individual, capital gains, and dividend tax rates. But it could also result in more fiscal spending, including an infrastructure package, and lower tariffs. A victory by President Donald Trump may help keep taxes low. Still, it also may lead to escalating tensions with China, more tariffs, and further decoupling of the trade relationship between the two countries. Regardless of the outcome, we expect bouts of market volatility.
For more information on our views surrounding the election, you can visit our website at:

How the 2020 election may impact your financial life

Portfolio Changes

As always, we keep a close eye on your portfolios, looking for new investment ideas and rebalancing opportunities to capture gains and reallocate into attractive sections of the market. In early September, we reduced equity allocations by 2%. Stocks have had a strong recovery from the March lows, and we took the opportunity to harvest gains and get back to benchmark weightings. We predominantly reduced the large-cap growth sector. Fixed income and cash increased as a result.

Most recently, we’ve reviewed the fixed income landscape and how best to position portfolios around historically low rates. Our existing core bond fund has delivered on the four P’s: Performance, People, Process and Price. We think we can improve by changing funds on the last P, Price. As a result, we will be changing the core bond fund to a lower-cost option. We expect the change to increase the quality of the bond portfolio. Simultaneously, we are consolidating our short-term bond fund into an exchange-traded fund with lower cost. Together, these changes will lower expenses and increase diversification.

Please reach out to your advisor if you have any questions or concerns.

[1] Morningstar Direct Style Box, as of 9/30/2020

[2] Per Morningstar US Large Growth TR Index and Morningstar US Large Value TR Index, as of 9/30/2020.

[3] Dimensional Fund Advisors

[4] AQR “Is (Systematic) Value Investing Dead?, 5/8/2020

[5] Morningstar Direct as of 9/30/2020.

[6] Alternatives benchmark includes 60% SG Trend Index and 40% Swiss Re Global Cat Bond TR Index.

[7] Sellwood Consulting

[8] JPMorgan, Guide to the Markets using the S&P 500. A bear market is defined as a 20% or more decline from the previous market high. The related market return is the peak to trough return over the cycle.

[9] JPMorgan, Guide to the Markets

IMPORTANT DISCLOSURES
Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any strategy or investment will prove profitable. As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility, therefore.

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This newsletter should not be regarded as a complete analysis of the subjects discussed. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy. The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily consider the particular investment objectives, financial situations, or particular needs of all investors. For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.

INDEX DEFINITIONS
The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It cannot be invested into directly.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of approximately 800 stocks and is designed to measure equity market performance in 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, , Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.
The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index of approximately 900 stocks and is designed to measure equity market performance in 21 developed market countries outside of North America.
The S.G. Trend Index is a subset of the SG CTA Index, and follows traders of trend following methodologies. The SG CTA Index is equal weighted, calculates the daily rate of return for a pool of CTAs selected from the larger managers that are open to new investment.
Swiss Re Global Cat Bond Index tracks the aggregate performance of all catastrophe bonds issued offered under Rule 144A. The index captures bonds denominated in any currency, all rated and unrated cat bonds, outstanding perils, and triggers. The index is not exposed to currency risk from non-USD denominated cat bonds.
Morningstar U.S. Growth Index tracks the performance of stocks that are expected to grow at a faster pace than the rest of the market as measured by forward earnings, historical earnings, book value, cash flow and sales.
Morningstar U.S. Value Index tracks the performance of stocks with relatively low prices given anticipated per-share earnings, book value, cash flow, sales and dividends.