November Market Update — Two Centuries Investments

Here are the top market developments we have been watching in November.

1. Value outperforms growth, as vaccines trump politics.

While markets were digesting the outcome of the US elections, on the morning of November 9, 2020 Pfizer announced favorable results for its COVID-19 vaccine. Immediately, US financial markets began to price in a return to economic normalcy, as stocks soared. Notably, value stocks outperformed growth stocks by almost 7% over the remainder of the month.

**The graph shows the total return for the iShares Russell 1000 Value ETF (IWD) in purple and the iShares Russell 1000 Growth ETF (IWF) in blue from November 6, 2020 to November 30, 2020.**

Did November mark an inflection point for value stocks, which up until the Pfizer announcement had underperformed growth stocks by over 100% over the prior four years?

In the near term, we would not be surprised by a continuation of value stock outperformance. Growth stocks have exhibited strong fundamentals, i.e., revenue growth and profit margin expansion, but have also greatly benefitted from increasing valuation, i.e., multiple expansion. A lot of good news was priced into growth stocks, a lot of bad news was priced into value stocks. Economic stability will boost value stocks and lead to mean reversion, i.e, the valuation gap between growth stocks and value stocks will shrink.

However, until the global supply chain adjusts to COVID-19 and trade dispute related disruptions and until economic growth accelerates organically and not in fits and starts based on government stimulus, growth stocks will likely remain in favor. Many growth stocks are stories of innovation and intangible capital, which represent secular tailwinds in a world of cyclical headwinds.

2. Has government stimulus peaked now that a vaccine rollout in imminent?

Our belief is yes, stimulus has peaked and will be dramatically lower in 2021. Thus far in 2020 we have witnessed a jaw dropping amount of government stimulus, both fiscal and monetary, already exceeding $20 trillion globally. It will be a bumpy transition back to private sector led economic growth. What will will be watching?

3. Credit risk remains ours biggest focus (and biggest concern).

As we discussed in July’s monthly update (here), credit creation is akin to the arteries in the body’s circulatory system. When the flow weakens too much, the economy will suffer. In September’s update (here), we expressed concern that the number of CCC rated (“junk” bond is apropos) issuers has markedly exceeded the peak level reached during the 2008 Financial Crisis. In last month’s update (here) , we noted some good names, namely the pace of bankruptcies has slowed from early summer. Back to a note of caution this month, as we note an increasingly number of companies in the Bloomberg Barclays U.S. Corporate High Yield Bond are posting negative Ebitda (earnings before interest, taxes, depreciation, and amortization) on a trailing 12 month basis.

4. We are also monitoring gold prices and cryptocurrency prices.

Gold and cryptocurrencies can serve as signals regarding investor confidence in the financial system and the value of the US dollar. Our concern is credit risk will increase as the transition from government stimulus led growth to private sector led growth occurs. Government policymakers have a track record of trying to smooth the impacts “creative destruction” and economic shocks. Additional doses of government stimulus in the US will increase concerns about USD devaluation and its offspring, inflation, as we previously discussed (here). Gold and cryptocurrencies will be the likely beneficiaries.

5. The final act of the election season has yet to occur.

Control of the US Senate is still up in the air. Democratic control of both houses of Congress, along with a Biden Administration, is likely to lead to a push for higher taxes and more regulation. Certain companies and industries may benefit, but lower economic growth and a lower stock market will be likely casualties.