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Head—Bernstein Private Wealth Management


It’s different this time. Many regard these words as among the most dangerous in the business of investing. This rings particularly true around peaks and troughs, when popular narratives explaining what’s happening at the moment become intertwined with heightened states of greed or fear. We witnessed this once again over the last three months as investors grappled with the pandemic, social unrest, and their combined impact to the global economy, all while at the same time being reminded of another time-honored Wall Street adage: Don’t fight the Fed.

With assets like stocks having substantially recovered from the lows of late March, where does this leave us? Beyond the known risks associated with pressure on our public health systems and failure to deliver a vaccine in 2021, questions for long-term investors fall broadly into three categories—cyclical growth, election politics, and interest rates. I’ll briefly touch on each in what follows. On balance, our base-case expectation for the intermediate term and beyond is below-average growth and asset returns. This is largely (and paradoxically) unchanged relative to a year ago, as is our call for diversification as the ultimate antidote to uncertainty.

What we sincerely hope is different this time is follow-through on the worldwide call to action for racial justice and a leveling of ingrained opportunity inequity. The energy around these issues inside our firm is at an all-time high, but Bernstein’s commitment to diversity and community is not new. We see the different perspectives that come from disparate experiences as essential to innovation and the avoidance of groupthink in decision making.

We also recognize that multicultural client engagement—including gender, orientation, and even generation—is essential in a world where decision makers are not one-dimensional. Our own employee composition does not yet reflect the diversity we aspire to, but an intentional hiring and talent development strategy has yielded tangible progress. To be clear, our goal is not to check boxes. We aim to strengthen the foundation of our business and foster a culture benefiting our clients that embraces big ideas from wherever, and whomever, they come. Doing this right will take time. But our direction is clear and unwavering.

The End of an Era

With the end of historic runs in both economic expansion and equity markets, some question whether the next cycle will be atypical (I didn’t say different) given the extraordinary circumstances surrounding the last one’s decline. Put another way, will what comes next pick up where we left off with consumer demand and growth stocks dominating? Or, will we see the start of a new cycle featuring broader economic growth and participation from stocks that have been left behind over the last several years as returns have become increasingly concentrated?

The pace of the decline in risk assets like stocks, as well as the speed and magnitude of the economic policy response, have all been unprecedented. So has the recovery—in stocks, at least so far (Display 1). And while risks remain around public health and economic policy, stock prices are always anticipatory and the recent run-up is justifiable despite the apparent disconnect with current economic reality. The case hinges on 2021 earnings recovering to 2019 levels, which itself depends on a vaccine or therapeutic breakthrough, with modestly higher multiples supported by lower interest rates. With the usual caveats about the unpredictability of short-term volatility and the aforementioned risks, we see stocks—especially in the US—as neither cheap nor expensive.

Stock Snapped back from Record Sell Off

If stocks are fairly priced at the moment, benchmarks may not have meaningful upside in the short term even as economic indicators snap back and demand improves. Mitigating downside risk is a record amount of cash on the sidelines. And at the portfolio level, the fact that large swaths of the stock market have lagged benchmarks in recent years suggests they could prove relatively protective in pull-backs, as well as offer greater upside potential to the extent a more powerful, broad-based and typical (not different) cyclical recovery takes hold with more clarity on health and stimulus risks (Display 2). We always advise against market timing and preach the benefits of diversification, but now more than ever.

Market Sub-Segments Poised for a Rebound in a Typical Cyclinical Recovery

Looking Ahead to November

History doesn’t offer a reliable guide to how markets react in the wake of elections, so dwelling on them in advance has never been worthwhile. I realize that’s hard to reconcile these days, no matter one’s political view. Either way, the stakes this year extend beyond the presidential race. Key questions for the markets and economy center around fiscal support, whether 2018 tax code changes will stand, and foreign policy—particularly as it relates to the choice between global market integration or deglobalization (Display 3).

Election Outcomes and Expectations for Stock Market Reaction

Markets generally prefer the status quo. It’s the devil it knows, and in this case assumes the extension of the current state for the aforementioned policies. As such, we’d expect an outcome where the GOP maintained control of the White House and Senate to be greeted favorably in the short and intermediate term. Though longer term, a continuation of policies decoupling the US from the rest of the world economy could present risks to growth by reducing corporate profits. On the flip side, Democratic control of the White House and Senate seems likely to cause short- and intermediate-term market anxiety, given the expectation that outcome would bring for tax increases. Whether Democratic policymakers would pursue such a path during an economic recovery is unclear. But in the same way we didn’t see lowering taxes as a game changer for the trajectory of future growth, we don’t see a reversal as a long-term risk either.

With President Trump’s poll numbers faltering, the possibility of a Biden win combined with a Republican Senate should be considered. In this scenario, renewed fiscal discipline among conservative lawmakers could present risks in the form of a reduction in federal support before the economy has fully recovered. With so many unknowns between now and November, it’s probably not different now, at least in markets which will likely look past political theater for the next few months.

Out of Ammo?

The final sphere the elections could influence is future leadership at the Fed. The president has clearly expressed his displeasure with Chairman Powell, and it seems natural that he would move to replace him in a second term. For our part, we regard Fed policy as appropriately aggressive thus far, though we are not proponents of the negative interest rates called for by the president. Evidence from markets with negative rates suggest little benefit in driving them below zero.

Instead, we expect a prolonged period where rates stay low and the Fed implements additional policy measures in the form of yield curve control. This would cap yields on two- and three-year Treasuries at the Fed funds rate through asset purchase activity. In his remarks on June 10, Chairman Powell noted, “We’re not even thinking about thinking about raising rates.” This represents good news for cash-flowing assets like stocks and bonds as it makes the present value of future cash flow more valuable today. That said, there’s a limit to the price (multiple) benefits that come with lower rates and we think we’re about there now.

In short, the trajectory of future growth will hinge mainly on fiscal and trade policy. Large deficits suggest risk of inflation but reckoning is not imminent, and technology adoption and societal aging are disinflationary offsets. Since the Financial Crisis, central bankers have tended to do the heavy lifting in managing economies while elected officials around the world have squabbled and turned inward. If this persists, the next cycle will likely look similar to the last—itself a departure from postwar history in that while it lasted a long time, it delivered much less robust growth. Evidence—despite how the saying goes—that sometimes things really are different.

As strange as it may seem, given everything that has happened so far this year, stocks around the world are up modestly from where they sat a year ago. And the conclusion of this letter—calling for low, but positive returns, as well as the benefits of diversification—remains largely the same as my sign-off last summer. Such is the nature of long-term investing. As frustrating as the narrowness of returns in some areas of the market have been, we take pride in having kept our clients invested through the last few months. We’re also excited to be part of conversations where philanthropy and impact, or responsible investing, have taken on greater urgency with the extraordinary challenges facing the communities where we all live and work, especially among the most vulnerable. We have deep expertise in these areas and are honored, as ever, to play a role in growing our clients’ capital while helping to make it more meaningful.

Thank you for your ongoing trust, and best wishes for health and happiness this summer.

David Barnard Signature

David Barnard

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