Building Back Better

Market Commentary | July 2020

Building Back Better

At the midpoint of the year, investors are understandably concerned in the face of material upticks in coronavirus cases. Yet, we observe the shock of the initial crisis evolving into energy for creative economic recovery. We have written in recent weeks about restaurants adapting to new delivery models, school curriculums relocating into the home, and the rise of video conferencing for everything from professional work, to telehealth provision, to family and social interaction. While equity prices may seem high in the context of the dramatic economic slowdown, the sharp recovery from March lows signals investors’ conviction that our economy will recover and resume resilient growth, similar to past crises.

In the three months following the sharp sell-off in March, the dominant theme has been an impressive price recovery in almost all global financial markets. This recovery was sparked by unprecedented central bank support, alongside fiscal support and stimulus in the US and other countries, and reflected hope that discovery of a vaccine and economic recovery would proceed on faster timelines than counseled by leading experts.

In the US, the Fed stabilized credit markets by dropping interest rates to 0-0.25% and implementing liquidity measures similar to the aftermath of the 2008 crisis. They acted swiftly, reaching similar levels of balance sheet expansion in 3 months that took 5 years of purchases in the prior crisis. This gave markets confidence that the Fed would use all tools at their disposal to support asset prices.

Congress further supported US households, small businesses, and state and local governments by issuing more than $2 trillion of fiscal support, in the form of PPP loans and direct stimulus payments. In addition, tax deadlines were delayed until mid-July to support liquidity for businesses and individuals. Lastly, the stimulus also included additional unemployment benefits through the end of July. Congress is now debating the details of a much needed next round of stimulus, and investors are carefully watching how that will impact the cash flow of millions of unemployed Americans and future corporate earnings.

The Fed and Congress can provide monetary and fiscal support. They cannot, however, force consumers to return to previous spending habits, cause state policymakers to pursue particular policies in support of economic activity, or create a clear timeline on vaccine development. While a certain amount of price recovery is justified, the rally may have extended too far, and too fast, and we may now face disproportionate downside in equity markets. Certainly, there has been no definitive resolution to public and economic health risks, as much as businesses and consumers are making a dramatic effort.

Headlines are quick to highlight the recovery of the S&P 500, but often discount the reality that the top companies of the 500 are driving virtually all of the index returns. Six companies – Facebook, Amazon, Apple, Google, Netflix, Microsoft – have produced a cumulative total return of 236% since 2015, the remaining 494 companies have produced a cumulative total return of only 39% over the same time period.¹

The top five companies, which excludes Netflix from the group above, comprise roughly 23% of the index, which exceeds the concentration of the Dot-Com Bubble, and is the highest in over 50 years. This, much like the plight of historic wealth inequality, is not a sustainable foundation for broad growth over time and poses a longer-range risk factor.

Looking beyond large US companies, the S&P 600 (an index of small-cap US companies) is still down -18% through June on lingering concerns about solvency and the ability to weather a prolonged recovery. International stock and emerging market indexes are similarly still down by -11.3% and -9.8% at midyear respectively.

This concentration emphasizes that the health of the overall investment landscape can’t be judged by only the top 5 tech companies in the S&P 500. While it is true that most financial assets have experienced price recovery since the severe lows in March, the headline return of one index doesn’t reflect the ongoing and disparate struggles in many industries, and across many geographies.

One of the bright spots this year has been investments that prioritize social and environmental considerations. Over the first four months, as markets dipped on pandemic concerns, the S&P 500 ESG index and the MSCI emerging markets ESG index both outperformed their more conventional counterparts.² The important part is the “why” and whether we expect this to be a long-term trend – the short answer to the latter, is yes.

MSCI defines ESG investing as the “consideration of environmental, social and governance factors alongside financial factors in the investment decision-making process.”³ Socially conscious investing assumes that financial strategy will be strengthened by consideration of all stakeholders, not just shareholders. Consideration of risks to the environment, employees, suppliers and local communities reflect a longer-term focus, rather than the more common concern about short term stocks price behavior.

Large companies are beginning to make encouraging commitments to expand consideration of all stakeholders – as we wrote about earlier in Moral and Economic Identities. During 2020, we’ve seen Salesforce announce a goal to support the conservation and restoration of 100 million trees over the next decade⁴ and Microsoft set a target to be carbon negative by 2030, and by 2050 to remove all the carbon from the environment the company has emitted since it was founded. Starbucks also announced a goal to reduce carbon emissions by 50% by 2030, and plans to conserve or replenish 50% of the water currently being used for direct operations and coffee production.⁵ ESG-oriented companies are positioned to benefit from changing consumer preferences that include a more meaningful emphasis on social responsibility, diversity, and preparation for a world that is less dependent on fossil fuels.

This investment style has benefited recently in part from being less exposed to oil companies, which have suffered in recent years from the dual storms of the US-China trade war and the total collapse of travel and transit during the pandemic. This explains only “a fraction” of the sustainable funds’ outperformance, according to Blackrock’s calculations. They attribute it to two other issues as well. One is increased interest by investors. In the first quarter of 2020, flows into global sustainable mutual funds were 41% higher versus the prior year, driven by younger and more diverse investors.

The second reason is more fundamental: better supply chain management and corporate governance. To get high ESG ratings, companies usually need to audit their supply chains, employee practices and internal logistics, changing them where necessary. They must also prepare detailed ESG reports to comply with frameworks such as those of the Sustainability Accounting Standards Board and measure progress over time. These efforts, along with improved diversity and gender representation at the board level, has created more resilient companies and incrementally better financial results.

Diversification is a hallmark of stewardship, and that increasingly includes social and environmental considerations. Investors are voting with their shares, and companies are starting to respond. As our economy as a whole deals with the disruptions of the pandemic and responds to concerns raised during recent social unrest, our country has a rare opportunity to pivot the trajectory of our growth going forward.

We are energized in our work with clients in their role as stewards of their family finances. We are similarly energized to work with them as stakeholders in their communities, and in the impact of the companies they invest in. The work of the shareholder and the citizen alike is critical work, and investment choices have the power to be part of that positive influence.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

¹ Wall Street Versus Main Street: The Disparity Between the Market and the Economy. July 6, 2020 Parametric Portfolio Insights

² Why ESG investing makes fund managers more money; By actually knowing their supply chains, do-gooding companies have made better returns. July 8,2020  Financial Times

³ MSCI Reseach; What Is ESG MSCI

⁴ Salesforce at Davos; January 24, 2020 Salesforce Press Release

⁵ 5 things to know about Starbucks new environmental sustainability commitment; January 21, 2020 Starbucks Press Release