October 2020 Thoughts and Insights
Our last newsletter focused on our investment process and how we are evolving with the markets. We would like to open again on this topic as it is so important.
Our investment process first assesses where we are in the business cycle in terms of growth (GDP) and inflation (CPI). The economy has four specific stages (expansion, peak, contraction, and trough) that can be graphed into quads (see below). Once we know what quad we are in, we then look at the relationships between price/volume/volatility to decide timing of investments.
In the last letter, we also talked about the VIX, which is an index that measures how many option contracts are currently bought on the Chicago Board of Options Exchange. These option contracts include puts and calls that banks, institutions and governments are implementing to hedge their portfolios. The greater the number, the more hedging is occurring, resulting in greater volatility.
Here is a chart of the VIX for 2020:
The red line is at 26 and the green line is at 16. Anytime the VIX measures above 26 the market is extremely volatile and considered “un-investable”. When the range is between 16 and 26 the markets are choppy. When the VIX measures below 16, the markets are considered stable.
So, by putting both the macroeconomic environment together with the technical environment, we make our investment decisions.
For Q3 2020 we had growth slowing and inflation accelerating. The dollar was weak due to COVID related stimulus giving us “stagflation”. As we enter Q4 2020, the dollar is strengthening as additional stimulus talks have stalled, and other countries are purposely weakening their currencies relative to the US. If the dollar continues to strengthen, we will unfortunately have slowing growth and declining inflation which means Quad 4 like we had in March of 2020.
Given a Quad 3 or Quad 4 economy along with the VIX greater than 26 since the beginning of September, we are positioning the portfolios defensively. This past quarter we actively traded: buying more treasuries, commodities, and gold; selling profits in tech, gold miners and emerging markets. We also added exposure to the Chinese market as China is experiencing a growing economy with muted inflation. We also performed our annual exercise in tax loss harvesting taking some losses to offset gains and then re-enter positions 31 days later. As a reminder, trades are now free at Schwab which gives us the freedom to “dollar cost average” over multiple trades versus one “all-in” trade. Apologies for the flood of trade confirmations.
Looking forward, we do not anticipate much trading over the next several weeks due to 1) October is historically volatile 2) Q3 corporate earnings will begin to report and 3) the election.
About the election, here are a few thoughts:
- Despite the attention-grabbing headlines, we do not expect the results to be the primary driver of the markets.
- Regardless of the outcome, the US economy will require more federal assistance in 2021. We also think a bipartisan trend toward onshoring certain manufacturing, and a growing anti-trade movement will continue.
- Taxes, spending and regulatory policies could look quite different depending on the outcome but a key lesson from 2016 was to avoid making high conviction bets that rely on one particular outcome to perform well.
Our immediate focus is on capital preservation and the current investment environment calls for patience, a global approach, and flexibility. We will be ready to add risk back into the portfolios at the first signs of reduced volatility and green shoots in growth.
As always, we remain dedicated to serving your investment goals. The Danda Family thanks you for all your prayers, care, and support. We treasure the relationships we have built over the years and are grateful for your trust in us.