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December 2020
A Vaccine Is on the Way, the U.S. Election Nears Resolution, and the Treasury Requests a Return of Relief Funds: How Did Markets React?
KEY OBSERVATIONS

A Vaccine Is Coming!

Equity markets took flight in November on promising vaccine news and prospects for a divided government in Washington, which is an old favorite for equity markets. When asked about the surging virus and the prospects for a difficult winter, most strategists provide the standard answer— the market is forward-looking. However, there may be some overlooked near-term resiliency. On Black Friday—or, should I say, Cyber Friday—most observers focused on the shift from bricks-and-mortar sales to online sales. While it was a tough day overall for bricks-and-mortar-stores, shoppers who did brave shopping in physical stores spent 36.3% more on average, according to a November 29 report from RetailNext Inc. Where is this consumer strength coming from? The Fed was quite clear in its recent minutes. No longer assuming any fiscal stimulus, the Fed noted:

“Although the lack of additional fiscal support was expected to cause significant hardships for a number of households, the staff now assessed that the savings cushion accumulated by other households would be enough to allow total consumption to be largely maintained through year-end.”

Time for International Equities?

No doubt you’ve heard this before, and perhaps for quite a long time: Your skepticism is warranted. Take for example the chart below. Ten years ago, many declared international stocks cheap, referencing that the MSCI EAFE index was trading at 70% of the price-to-book value of the S&P 500. But that was higher than the long-term average of 65%. A decade of underperformance has driven that number below 50%, so maybe now really is the time.

Price-to-book value is a ratio of a company’s (or index’s) price to its book value. Book value measures the value of a company (or index’s) total assets minus total liabilities.




CHART OF THE MONTH:
INTERNATIONAL DEVELOPED MARKET EQUITIES MAY BE ATTRACTIVELY VALUED

Source: Bloomberg, ProShares



There are lots of arguments on top of valuation that support a bullish view on international equities, including a declining dollar, less technology, more cyclicals and enhanced European integration. However, rather than asking yourself whether you are on board with the bull case, ask yourself how confident you are with respect to the bear case. Many investors often seem to act as if they were clairvoyant with respect to international equities. Developed international equities account for 25% of the world’s equities according to Bloomberg, yet many investors often have none in their portfolios. That would only make sense if you were virtually certain that they were going to perform poorly. A disciplined investment strategy underweights but does not eliminate. So maybe you’re not on board with having lots of international equities in your portfolio, but now may be an important time to consider at least having some.

PERFORMANCE RECAP

All Green in November.

Returns of various common market segments

Source: Bloomberg


Equity Perspectives
Weakening Dollar Aids International Developed Stocks

Positive vaccine news and at least some level of clarity on the likely outcome of the election were the fuel that ignited November’s powerful equity gains. November’s 12.1% return for the Dow Jones Industrial Average was the strongest monthly return since 1987. While domestic cyclical sectors and the so-called recovery themes received much of the attention because of strong performance, international developed stocks also rallied sharply. The MSCI EAFE returned 15.5% for the month, outperforming the S&P 500. Though trailing the S&P 500 on a year-to-date basis (and by a substantial margin since the financial crisis), the MSCI EAFE has now outperformed domestic large caps over the past three- and six-month periods. Of course, such short time periods do not make a trend, but it bears watching.

Recent dollar weakness has been aiding returns for U.S.-based investors. Since peaking on March 20 and nearly coincident with the equity market bottom, the U.S. Dollar index has fallen 10.7%. More recently since the election, the U.S. Dollar index fell on expectations that a new administration would not be as eager to pursue higher tariffs and a trade war, thus providing at least some measure of clarity for a potential bounce in global trade. If the dollar continues to fall, and cyclical sectors like financials, industrials, and energy continue to recover, look for international developed stocks to potentially continue their recent run of outperformance.

Choose Your (International) Dividend Stocks Wisely

A distinguishing characteristic of domestic equity markets in 2020 has been the wide dispersion of returns between sectors and styles. Said differently, it’s been a market of haves and have nots. Despite recent outperformance, value still trails growth. Energy stocks are still deeply in the red and trail information technology stocks by more than 70%. Domestic stocks that have cut their dividends have trailed stocks that have raised their dividends by a wide margin. A related dynamic among dividend stocks is that dividend growth strategies (like the S&P 500® Dividend Aristocrats® Index) have outperformed high dividend yield strategies (like the Dow Jones U.S. Dividend Index).

International dividend strategies are following a similar pattern. Take the MSCI EAFE Dividend Masters Index, a collection of international developed stocks that have raised their dividends for a minimum of 10 consecutive years. This dividend growth strategy has outperformed the DJ EPAC Select Dividend Index—an index of high dividend-paying companies in developed markets outside of the United States—by over 16% thus far in 2020. And outperformance isn’t limited to the recent past. Since its inception in 2014, the Dividend Masters index has outperformed high dividend yield strategies on a consistent basis. As we wind down a challenging 2020 and look ahead to 2021, there’s never been a better time to review strategic portfolio allocations. Given domestic stock outperformance of late, many are likely to underweight a key component of a well-diversified global portfolio. Dividend growth stocks with stable businesses, solid fundamentals and the earnings resiliency to continue raising dividends are well positioned across international markets.

Source: Morningstar as of 11/30/20. MSCI EAFE Dividend Masters Index inception date of 7/14/14.



Fixed Income Perspectives
Tensions Develop Between the Fed and the Treasury Department

On November 19, Treasury Secretary Steve Mnuchin requested the return of more than $400 billion from the Federal Reserve’s pandemic relief package. Earlier on in the pandemic, the initial announcement of the Fed’s stimulus package had helped to support confidence in the corporate bond market. Mnuchin’s recent request raised some eyebrows as it effectively called for the claw back of a portion of these funds, causing some to question the Fed’s ability to continue to support corporate bonds. In a rare move, the Fed indicated dissent in response to his request, stating that it “would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy.”

It’s important to keep in mind that only a small fraction of the money allocated to the Fed’s relief package was actually deployed in purchasing corporate bonds. So far, it appears that Mnuchin’s request has not reduced confidence in the bond market and may have been partly overshadowed by promising news on the vaccine front. In fact, credit spreads tightened an additional 21 basis points (bps) during the month of November.

Source: Bloomberg



Is the Disconnect Temporary?

Further easing bond investor concerns, President-elect Biden selected Janet Yellen as his pick for Treasury Secretary only a few days after Mnuchin’s request. Yellen previously served as Fed chair, and if confirmed by Congress, is likely to smoothen the link between two of the key decision makers of fiscal and monetary policy. The ability of these policy makers to work cohesively is a key factor in the effectiveness of economic stimulus. All things considered, corporate bonds were up 2.8% in November, outperforming the broader aggregate bond market, which was up 0.98%. In addition, high yield bonds were up nearly 4%. With respect to interest rates, the yield curve flattened ever so slightly, with 10- and 30-year Treasury yields falling 3 bps and 9 bps respectively. As such, Treasury bonds were fairly flat for the month, up just 0.35%

The yield curve is a graph that plots interest rates (yields) for U.S. Treasury debt at different maturity dates.


Source: Bloomberg. Corporate Bond market tracked by the Bloomberg Barclays Corporate Bond Index. Aggregate bond market tracked by the Bloomberg Barclays US Agg Bond Index. High yield bonds tracked by the Bloomberg Barclays US Corp High Yield Index. Treasury bonds tracked by the Bloomberg Barclays US Treasury Index.

ProShares Investment Strategy Team

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Sources for data and statistics: Bloomberg, FactSet and ProShares

The different market segments represented in the chart use the following indexes: U.S. Large Cap: S&P 500 TR; U.S. Large Cap Growth: S&P 500 Growth TR; U.S. Large Cap Value: S&P 500 Value TR; U.S. Mid Cap: S&P Mid Cap TR; U.S. Small Cap: Russell 2000 TR; International Developed Stocks: MSCI Daily TR NET EAFE; Emerging Markets Stocks: MSCI Daily TR Net Emerging Markets; Global Infrastructure: Dow Jones Brookfield Global Infrastructure Composite; Commodities: Bloomberg Commodity TR; U.S. Bonds: Bloomberg Barclays U.S. Aggregate; U.S. High Yield: Bloomberg Barclays Corporate High Yield; International Developed Bonds: Bloomberg Barclays Global Agg ex-USD; Emerging Market Bonds: DBIQ Emerging Markets USD Liquid Balanced.

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Bonds will decrease in value as interest rates rise. International investments may also involve risks from geographic concentration, differences in valuation and valuation times, unfavorable fluctuations in currency, differences in generally accepted accounting principles, and economic or political instability. In emerging markets, many risks are heightened, and lower trading volumes may occur. Small- and mid-cap companies may lack the financial and personnel resources to handle economic or industry-wide setbacks and, as a result, such setbacks could have a greater effect on small- and mid-cap security prices.

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