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September 2020 Economic Commentary

What the Experts Say

In spite of historically strong market performance since March, we still face risks from global trade tensions, an insidious virus, the possibility of a contested election outcome, and an economic recovery that is standing on weak legs. In the midst of this v-shaped market recovery, historic PE multiples, and “shock and awe” fiscal and monetary intervention, I thought it would be helpful to check in with some of the thought leaders I have found to offer value during times of crisis and volatility. While most of the Street has turned bullish, these thought leaders have a more balanced and cautious view of our current situation.

Take Warren Buffett’s recent allocations to gold miners and Japanese trading companies. With these investments, he is telegraphing a bearish view toward the dollar, and possibly an aversion to the nose bleed valuations of US equities. In addition, he is maintaining a significant amount of dry powder due to the uniqueness of this pandemic-driven recession, and was recently quoted as saying, “It took me 89 years to experience something like this.” The Oracle of Omaha has been humbled by this crisis and continues to take a cautious approach.

Ray Dalio, the largest hedge fund manager in the world, shares Buffett’s outlook on gold and the dollar, and has a fatalistic view of recent government intervention and current overvaluation. He recently quipped, “Capital markets are not free—the Fed is boosting asset prices; valuation metrics don’t apply and the US dollar is at risk. You are going to see central bank balance sheets explode, multiples shouldn’t be used in the traditional way as a frame of reference…investors should avoid cash and bonds.” The last point about bond avoidance seems the most interesting. We are witnessing the end of a 40-year bond market rally. US Treasury yields are close to zero and have little room to turn negative as they have in other developed countries, but 5 to 10 year expected returns stand at around 1%. How can you build a portfolio when 30-40% of your asset allocation is providing a 1% annual return? Fund managers will need to find creative alternatives to fixed income, or else push further into the risk spectrum.

David Tepper, consistently one of the highest paid asset managers in the business, is having serious trouble finding value in this market. In a recent roundtable he declared, “This is the second most overvalued market I have ever seen, behind only ‘99. The Fed has created a distortion in allocation of capital, and the market, by anybody’s standard, is pretty full.” With that said, Tepper is finding opportunity in dividend paying stocks, and recently increased his position in AT&T as both a value and yield play.

The most bearish award goes to Stanley Druckenmiller, who claimed, “Everybody loves a party…but, inevitably, after a big party there’s the hangover. Right now, we’re in an absolute raging mania. I have no clue where the market is going to go in the near term but I would say the next three to five years are going to be very, very challenging.” Druckenmiller has a history of fighting the Fed, but his point about the next three to five years being painful could have some validity to it. When PE mutiples are has high as they are right now, forward returns tend to be fairly poor without significant earnings acceleration.

It always helps to check in with thought leaders who offer valuable insights in times of uncertainty, but we are also proud to chart our own path. We borrow pieces of wisdom as we chart our course for 2021 and set our asset allocation targets. As always, we focus part of the portfolio on Large Cap dividend growth at a reasonable price. With valuation as stretched as it is and the dollar showing signs of weakness, we are using gold as a counterbalance. And, importantly, we still think it is critically important to devote a meaningful allocation to growth, which should continue to garner higher multiples in a growth-starved world. Finally, we are using cash to take advantage of opportunities and dislocations as they arise.

Please let me know if you have any questions via phone at 804-774-2087 or email at Jesse.Ellington@middleburgfinancial.com.

Past performance quoted is past performance and is not a guarantee of future results. Portfolio diversification does not guarantee investment returns and does not eliminate the risk of loss. The opinions and estimates put forth constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

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