Unequal Impact, Unequal Recovery

Market Commentary | Third Quarter 2020

Unequal Impact, Unequal Recovery

Since the onset of the pandemic and the resulting economic downturn, financial commentators have debated the likely alphabet shape for the economic recovery that would follow. The most common examples are U, V, W, and L. Initially, there were hopes for a “V” shaped recovery that would allow a sharp bounceback in economic activity across all industries. Many people clutched to optimism that the virus would be contained, and precipitous price declines could reverse quickly. The combination of a highly contagious virus, a lack of clear information, and variable compliance with social distancing all ensured that was not the case. Further speculation considered a “W” shaped recovery with second waves and corollary market reactions, or even a “U” shape with a longer recession before recovery emerged.

As we conclude Q3, with the virus still rampant, a new alphabet letter has emerged:  the “K” shape. This pattern goes beyond a full market aggregate and recognizes the dramatic variation in recovery among different industries and demographics. Some are successfully navigating this pandemic environment due to good fortune or savvy adaptation, but many others are struggling to stay afloat. There has been a dramatic disconnect between rising stock prices driven by a few highly visible companies (see: Amazon, Tesla, or Apple) and the broad carnage amongst small businesses and lower-wage workers. While diversified portfolios have largely gained back the losses from earlier this year, the larger economic recovery theme has been inequality.

The sudden disruption brought by the coronavirus accelerated trends already underway in the business landscape: remote work, automation, and e-commerce. As we have written about previously, the companies that had already established themselves in the digital landscape have fared better. The pivot away from brick and mortar retail to online shopping has been staggering. Amazon has posted record sales, and services including grocery delivery have seen widespread adoption. The transition to remote work has meant that any company providing video conferencing or connectivity support has also been a major beneficiary. These shifts benefit specific industries while leaving other companies and millions of unemployed workers to wonder when or if the recovery will reach them in time.

The rise of wealth inequality over many decades has contributed to the current dystopic backdrop of 2020 and represents a forward risk for economic resiliency. The wealth gap between America’s richest and poorest families more than doubled from 1989 to 2016, and the rate of inequality increased even faster than other developed nations.¹ The pandemic dramatically exacerbated these trends.

According to the Washington Post, low-wage jobs have been lost at about eight times the rate of high-wage jobs,² with a more pronounced impact on workers of color and women.³  Millions were forced to turn to unemployment benefits to make rent payments and buy food. Those benefits have decreased on average, from over $900 a week in April, May, June, and July, under the first federal stimulus package, to approximately $300 a week now on state benefits alone. The wellbeing (and spending) of these households is an important component of the American economy, and it is at risk.

As we go to press with this commentary, policymakers in Washington continue to debate the extent and the character of additional stimulus that could address these challenges. The upcoming election is magnifying that process, provoking chaotic movement toward a deal that will carry us forward into the next administration. We can’t predict the outcome, but we are hopeful that any deal reached will disproportionately benefit the workers who need it the most, including those with relatively low income, who work for local government, or who are struggling to continue running their own small business.

Inequality also persists within the stock market. In the S&P 500 for example, the top 25 performing companies have an impressive average return of 79.9% through Q3 of this year, but the remaining 475 companies in the index are experiencing an average decline of -5.5% on the year.⁴ Asymmetry of this magnitude does not reflect a healthy economy and is not sustainable as time progresses.

While worsening inequality represents a material risk, in a “K” shaped recovery certain segments are also doing well.  We already referenced the handful of large tech companies that dominate the S&P 500 as a key example.  Due to the cap-weighted methodology of the S&P 500, meaning that larger companies have outsized influence, the index was able to post a gain of +5.6% through the end of Q3 – quite the turnaround from the -30.8% at its low point on March 23. Our portfolios emphasize diversification and broad ownership in the US equity market, and that strategy has benefited portfolios this year.

Diversification also means we own asset classes that haven’t seen such rosy recovery patterns. Small and mid-cap stocks in the US are still down -15.3% and -8.6% respectively. International stocks are still down -7.1% and real estate is -13.8% through the end of September. Recovery in these areas accelerated in Q3, but further gains will depend on improved unemployment data, which in turn means material progress on a vaccine for the coronavirus.

In a difficult year for stock prices, allocation to bonds has been a bright spot.  The Barclays US Aggregate Bond Index gained +6.8% through the end of September. As we wrote in our article about the Magic of Bonds, the value of this allocation is both improved portfolio stability and the opportunity to invest in future growth through the process of regular rebalancing. We continue to increase the quality of the bonds we hold and remain committed to rebalancing as a key strategy for navigating this volatile market.

We are encouraged by the fact that our portfolios that consider factors related to environmental sustainability and the proven benefits of diverse workforces and management teams⁵ have been strong performers this year. This performance, in part, is due to the lack of exposure to oil production, which has experienced precipitous price declines with travel largely halted. Looking forward, the market’s cautious expectation of a Biden/Harris administration is providing an additional tailwind, with likely policy shifts on environmental regulation plus a stated appetite for large scale spending on sustainable infrastructure. We expect these portfolios to continue to be resilient as the global economy further embraces renewable energy to combat the threats of climate change.

The importance of renewable energy and carbon reduction is clearly supported by the scientific community, and the recent financial outperformance is the result of both consumers and investors voting with their dollars. Whether in your portfolio or at the ballot box, voting is a way to raise your voice in support of the world you want to see.

Despite the disruption and stresses of the pandemic, many of our clients have been able during this time to create a positive impact in their communities. Some have opened their houses to friends or family impacted by wildfires, others have made charitable contributions to donor-advised funds (DAFs) and specific relief efforts, and many have helped their children and grandchildren who are navigating the lack of childcare while working from home. Despite the inequality in markets and other aspects of life, we want to spotlight the ways that real connection is still being built and progress is being made.

As we enter the 4th quarter and continue to build new routines that support safe interaction, we are proud to be partnered with our clients as they vote for a world that is aligned with their values.

¹ Trends in income and wealth inequality. By Juliana Menasce Horowitz, Ruth Igielnik, and Rakesh Kochhar. Published January 9, 2020. Pew Research Center

² The covid-19 recession is the most unequal in modern U.S. history. By Heather Long, Andrew Van Dam, Alyssa Fowers and Leslie Shapiro. Published Sept. 30, 2020. Washington Post

³ Ibid., and “Downturns tend to reduce gender inequality.  Not under Covid 19,” The Economist, Finance & Economics section, June 4, 2020.  Women and workers of color hold a larger proportion of low wage, public contact jobs that disappeared, and lack of child care and open schools presented additional challenges for mothers disproportionately than fathers.

⁴ Performance of S&P 500 component companies; SlickCharts.com

⁵ Diversity wins: How inclusion matters. Published May 19, 2020. McKinsey & Company