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McCarthy & Cox News and Articles

Press Release | August 13, 2021

McCarthy & Cox Charity Outing a Success

The 9th annual McCarthy & Cox Charity Golf Outing was an enormous success, raising a record $24,930 for two charities! “We are very thankful for the outstanding turnout and support from our community and corporate sponsors,” commented Jim Cox, Managing Partner of McCarthy & Cox.

“Tom McCarthy and I started the McCarthy & Cox Cares Fund in 2013 to assist seniors, youth, and to fill emergency needs in Union County. To date, the Fund has donated more than $50,000 back into our community. The Cares Board manages the grants and consists of five current McCarthy & Cox clients who independently review requests from the community. For more information or to apply, we encourage people visit McCarthyandCoxCares.com,” Cox shared.

“The Elizavèta Fund also benefits from our annual golf outing, which Jim and Faye Cox founded in 2014 to assist families with the financial burden of adoption costs. Jim and Faye adopted their daughter, Caroline Elizavèta, from Russia in 2011. Throughout their adoption process, they came to realize the financial and time commitment that is required and decided to help others who wanted to grow their families in the same way. Over the years, the Elizavèta Fund has granted nearly $70,000 to assist 16 families, aiding in the adoption of 21 children. For more information, visit ElizavetaFund.org,” McCarthy noted.

Both funds are housed at the Union County Foundation and donations are tax deductible.

9thAnnualGolfOuting
 

 


August 2021
Mid-Year Update | Economic & Investment Management Perspectives


Finally.

I went to Kroger a few weeks back and was able to pick out my own doughnuts rather than buy a box that the bakery had carefully pre-selected and packaged for me. When I left, I could leave through either door. Habits are hard to break so I still went out the one everyone was forced to use during the pandemic.

Recently, I traveled to San Juan. While there, I went to a breakfast buffet where I was able to get my own food rather than having to say my order out loud, piece by piece, to a waiter behind the buffet. I had to wear gloves, but I didn’t care because I could fill my plate obnoxiously full of bacon and scrambled eggs.

It feels like everything we’ve said over the last 15+ months has been about Covid-19, and rightfully so. It was unlike anything we’ve ever seen in terms of impact – both on a personal level and economic level. Globally, over four million people lost their lives, and we likely all know someone who either contracted the disease or lost their job. Entire industries were shut down. Unemployment skyrocketed. Restrictions kept people homebound. But finally, a return to some semblance of normal. And I finally get to write about the recovery.

Before we get started, we’d like to remind you of some of the things we always do at McCarthy & Cox to manage risk on an ongoing basis, not just when a crisis occurs.

On the equity side, we place an emphasis on high-quality companies, those with long track records of profitability, rising cash flows, good liquidity, and strong balance sheets. These are typically larger and more mature companies and have the flexibility to either return capital to shareholders or reinvest in their company leading to higher future growth. Companies that fit this bill have historically held up better during market turbulence than the broader market.

Turning to fixed income, we have continued to hold a series of high-quality, core fixed income positions. Traditionally, fixed income has two primary purposes in a portfolio: to generate income and to mitigate downside risks. With yields near all-time lows, it’s nearly impossible to generate meaningful income from fixed income. But the other purpose - mitigating risks -  is still relevant, and this is where the high-quality, core fixed income positions come into play.

And finally, McCarthy & Cox has utilized Structured Products in many of our investment models for some time. Structured Products provide access to certain asset classes, but with the benefit of partial downside protection provided the product is held to maturity. This serves to lower the overall risk of an already diversified portfolio with the tradeoff of capping the upside potential.

Now for the rest of the year. As we wrote in our Annual Outlook, there were several themes we thought would shape the markets in 2021: expected volatile and choppy markets as we work through the recovery, continued challenges in the fixed income market, and finally, what would be the longer-term impacts from Covid-19?

A quick reminder about the business cycle: The economy ebbs and flows. There are good times and times when things aren’t so good. These “good” times and “bad” times fluctuate around some long-term average, much like the temperatures fluctuate between milder in the Summer and colder in the Winter each year.

When things are good, we spend more because we’re confident about the future. We purchase a new car, dine out more, or take an extra vacation. Companies may recruit new staff, build new buildings, invest in technology, etc. to create more products and services. Their expenses go up, and these expenses are passed on to consumers. At some point, we’ll slow our spending, and companies will cut prices to get rid of excess inventory. They may also lay off workers and sell some of these new buildings. When we hear about this, we aren’t so confident about the future anymore. This is known as the business cycle. And while it normally takes years for an economy to go through this cycle, we went through much of it in 2020 alone, and we now sit somewhere near early-to-mid cycle. As a reminder, the last time the economy was at this point was shortly after the 2008-09 housing crisis – which only recently ended with the pandemic.

What used to be called “cabin fever” is now “pent-up demand” as it relates to travel and other things we missed while quarantined, and “retail therapy” has turned into “revenge shopping”. There is still a lot of cash on the sidelines from both government stimulus and reduced spending over the last year-plus, considerably more than at the end of the housing crisis. Consumers have started to spend this cash which has increased the demand for goods and services beyond what our economy has been able to provide. This has spurred inflation, although it should be temporary. More on that later.

Coming into the year, we were expecting volatile markets and the emergence of new market leadership. Growth stocks had outperformed value stocks for four years, leading to one of the biggest disparities in history between the two styles. Many of the winning stocks in the early stages of the pandemic were those that provided technology to work from home, telemedicine, online learning, e-commerce, video streaming and social networking, and the gap between growth and value stock returns widened further. Because of this, relative to their growth counterparts, many value stocks became extraordinarily undervalued.

As the economy has reopened, however, a rotation back to value has occurred. These companies tend to do well early in an economic recovery. Although our models already held value-oriented positions, we added to strategy to gain more exposure to areas of the market expected to benefit from the reopening. Additionally, it slightly increased our exposure to financials, which should benefit if rates begin to normalize.

Small and mid-cap stocks are also favored by the early cycle environment. The recession is over, and we are early in a new business cycle. Like value stocks, small caps have historically performed well as the economy moves through this stage. We’ve adjusted our exposure there and should benefit from this as we work through the cycle.

And internationally, valuations continue to look relatively attractive. We’ll keep an eye on this throughout the remainder of the year and look to take advantage of any opportunities.

Moving on to our broken record portion, we thought the fixed income environment throughout 2021 would be challenging, at best. You’ve undoubtedly read articles recently about the death of the 60/40 portfolio. If not, google it and read any of the 192,000 results you’ll get. They’re based on this: with interest rates near historic lows, they must go up at some point. And since bond prices fall when rates rise, bond prices will therefore suffer.

But like many things in the investment world, interest rates are incredibly hard to predict. Economists are notoriously bad at predicting rates, including those at the Federal Reserve. Looking through the 192,000 search results, some of them date back to late-90s, and the message was the same: rates were near historic lows, everyone knew they were going up, and bond prices would suffer as a result.

Further, the Federal Reserve was in the middle of a hiking cycle. This should be bad for bonds, right? Death of the 60/40 portfolio. Sell your bonds and go all equities. Well, had you done that, you would have had more money in your pocket now. The all-equity portfolio would have returned 7.5% per year while the balanced portfolio would have returned just 7.0% per year. However, unless you had a stomach of steel, you probably would have sold out of the all-equity version during one of the three market corrections as it had twice the risk.

Incidentally, there was also an article that appeared in the search 1979 titled “The Death of Equities”. Hopefully no one read it…

The moral of this is to always maintain high-quality core fixed income in your portfolio to balance out equity risk - regardless of where the “experts” expect rates to go. No one truly knows. Not even the Fed.

Speaking of the Fed, it has promised to hold its policy rate close to 0% until inflation is on track to “moderately exceed” the central bank’s 2% target “for some time.” They’ve also continued to reinforce their bond-buying program and have asserted they’ll give plenty of notice before this changes. With all this liquidity, we should get used to a low-yielding environment for a prolonged period. And while they’ve had a horrible record of predicting interest rates, they directly control the policy rate and their bond-buying program, and this should indirectly carry over to longer-term rates.

And finally, what about any lingering impacts from Covid-19? How would this impact the markets and economy? Inflation has grabbed headlines recently, but much of the reason behind the spike will soon be over: the base rate effect. Inflation is measured as the price of a basket of goods from one year to the next; we weren’t spending as much last year on travel, clothes, entertainment, etc. – this is called the base rate effect. The base rate effect will largely have passed by the end of 2021.

Beyond the current spike, inflation is expected to cool over the intermediate term. Capacity constraints should ease as supply chains are repaired and supply/demand imbalances correct, pent-up demand will subside, and as workers rejoin the workforce later this year, companies should have additional capacity and wage pressures should subside. So, think of any increase in inflation as reflation back to normal long-term levels, rather than overheating to levels of concern. Look beyond the headlines – which are based on comparisons from 2021 to 2020 - and compare 2021 to 2019; this provides a much more accurate picture.

That said, there are some ingredients that could keep inflation slightly elevated in the short-to-intermediate term, but our base-case scenario is not for long-term runaway inflation. Keep in mind however, even if inflation were to fool us all and continue to climb, equity markets have historically performed well during such periods when coming from low levels.

The economy and markets have come a long way, but risks remain.

The United States has progressed quickly through a recovery and is now in an expansionary phase. Half of the population has been fully vaccinated, and most of the developed world is close behind. Economic growth is picking up steam and policy remains supportive.

Equity markets have continued their climb from the market lows of March 2020. Equities have the support of positive outlooks for economic and earnings growth in the coming years, along with strong consumer and business spending. With an extremely accommodative Fed, the backdrop is extremely favorable. However, market volatility reminds us that we’re not out of the woods just yet.

Inflationary concerns are grabbing the headlines, and we must focus on the Fed’s potential changes to monetary policy as we move through the remainder of 2021. In addition, though we have made lots of progress with the pandemic, the emergence of new variants - such as the Delta variant - could hurt the economy. Consumers have led the recovery, but a large surge in the virus would be reason for concern. We are certainly better prepared now than we were in February of 2020, so economic damage should be minimized.

The National Bureau of Economic Research recently declared that the recession ended in April 2020, just two months after it began, and confirming a new cycle began. If this cycle at all resembles past cycles, we’d expect this recovery/expansion cycle to be measured in years, not months or quarters. We therefore view any pullbacks as buying opportunities for long-term investors.

In summary, as the market continues to evolve in response to the virus, inflation, interest rates, and anything else that unfolds over the remainder of 2021, we remain keenly focused on monitoring the strategies held across the MC Select platform and identifying opportunities. As always, a diversified portfolio and long-term view still offer the best route to reach financial goals.

Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged, and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
Structured investments may not be suitable or appropriate for all investors. Your particular needs, investment objectives and financial situation were not taken into account in the preparation of this section of the website and the materials contained herein. You should consult your financial and tax advisor to determine whether a product is suitable for you and your investment needs and objectives. You must make your own independent decisions regarding any securities or financial instruments mentioned herein. You should consider whether an investment strategy or the purchase or sale of any product is appropriate for you in the light of your particular investment needs, objectives, and financial circumstances.
This communication is for McCarthy & Cox clients only and may not be distributed to the general public.
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Commonwealth Financial Network does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.


 

Understanding the American Rescue Plan Act of 2021

On March 11, 2021, President Biden signed the American Rescue Plan Act of 2021 (“the Act”) into law, with large portions of the bill acting as an economic stimulus for individuals and businesses affected by the COVID-19 pandemic. At $1.9 trillion in total expenditures, the bill contains provisions pertaining to a variety of areas. This summary is intended to address only the critical provisions for individuals and small businesses.


Direct Payments to Individuals

Much like the previous two coronavirus-related stimulus actions, individuals and families with incomes below certain thresholds can expect to receive a stimulus check (or direct deposit) from the government.

Filing Status

Adjusted Gross Income (AGI) Less Than . . .

Payment Amount

Complete Phaseout at AGI of More Than . . .

Individual

$75,000

$1,400

$80,000

Head of household

$112,500

$1,400

$120,000

Married filing jointly

$150,000

$2,800

$160,000


In addition, families will receive an extra $1,400 per dependent. The term “dependent” is an important change in this legislation, as previous stimulus funds were only applicable to taxpayers with children younger than 17. Accordingly, taxpayers with older dependent children, or other dependent family members living with them, will now see an enhanced payment amount.

Taxpayers with adjusted gross income (AGI) above established thresholds will see their eligibility for a payment phase out more quickly than under previous legislation. Regardless of the number of dependents, taxpayers with income that exceeds the upper phaseout threshold will not receive a payment at all. For those taxpayers within the phaseout range, their stimulus payment can be determined using the following formula:

(AGI – applicable threshold) / (upper phaseout threshold – applicable threshold)

For example, a married couple filing jointly with three dependents and an AGI of $155,000 would be eligible for a base stimulus of $7,000: $2800 + (3 * $1,400). They can calculate their reduction as follows: ($155,000 – $150,000) / ($160,000 – $150,000) = 50 percent of their base stimulus amount of $7,000, for a total stimulus of $3,500.

The determination of income will be based on taxpayers’ 2019 income tax return. If individuals would be entitled to a higher payment if 2020 AGI figures were used, they can file their return to claim eligibility to the higher payment. If a taxpayer receives a stimulus payment based on 2019 income and, thereafter, files a 2020 return with a lower AGI that entitles them to a higher payment, the government will use the 2020 AGI amount and supplement any payment already made based on 2019 income. To receive credit for a stimulus payment based on 2020 AGI, however, they must file their return by September 1, 2021, which is before the typical tax return filing deadline of October 15 for taxpayers who have requested an extension to the April 15 deadline.

A final opportunity for the maximum stimulus payment amount would come when taxpayers file their 2021 income tax return. If that return yields an AGI figure that entitles taxpayers to a higher amount than their 2019 or 2020 income did, they will receive a refundable tax credit equal to the increased stimulus payment amount eligibility.

The timing of the checks is not definitive, but government officials have expressed their intent to have payments sent as soon as administratively possible.


Expansion of Unemployment Benefits

Unemployed individuals, including those who typically aren’t otherwise entitled to unemployment compensation under state law (e.g., self-employed) and self-certify that they have been adversely affected by the COVID-19 pandemic, may receive unemployment compensation for an additional period of up until September 6, 2021.

In addition to any weekly unemployment compensation available under state law, unemployed individuals are entitled to an additional $300 per week for a period lasting until September 6, 2021, termed Federal Pandemic Unemployment Compensation.

The bill allows for up to $10,200 of unemployment income per individual to be tax free, subject to income limits. The stated income limit is an AGI of $150,000, which would include the sought-to-be-excluded unemployment income. The bill does not specify different income limits based on tax filing status (e.g., single, married filing jointly), and, therefore, it can be reasonably assumed that the AGI limit of $150,000 applies to all filing statuses. Additionally, the $150,000 AGI limit for unemployment income to be considered tax free is not a phaseout threshold; rather, it appears to be a “cliff,” meaning that if a taxpayer’s total AGI exceeds $150,000, they would not receive any tax-free treatment of benefits under the bill.


Loans to Distressed Small Businesses

The Paycheck Protection Program (PPP) will receive $7.25 billion in additional funding. Small businesses (defined as those employing 500 or fewer employees) will be eligible for forgivable, government-backed small business loans under the PPP. The same basic eligibility standards previously adopted for the PPP will remain applicable, and the window to request a loan will still close on March 31, 2021, unless otherwise extended.

The Act also provides funding to increase the accessibility of an Economic Injury Disaster Loan (EIDL) related to the COVID-19 crisis to the extent enough funding is available. Funds will be targeted from this program specifically to assist businesses with fewer than 10 employees and that suffered a substantial decrease in revenue.

A new Small Business Administration program designed to provide assistance to the disproportionately affected restaurant industry, called Restaurant Revitalization Grants, is funded in the Act. Similar to the PPP program, these tax-free Restaurant Revitalization Grants would be offered based on several conditions related to a loss of revenue due to the pandemic. Certain companies are excluded from eligibility for these loans, including restaurant chains with more than 20 locations and publicly traded companies. The first 21-day application period will be reserved for certain groups of owners (e.g., women-owned businesses, veterans).


Child Tax Credit

Many taxpayers will see an increase in their available child tax credit for the 2021 tax year from $2,000 per qualifying child to $3,000 per child age 6 and older and $3,600 per child younger than 6 as of December 31, 2021. Although the child tax credit is typically not subject to AGI limitations, the Act does put income limits in place for the enhanced credit amount over the typical $2,000.
 

Filing Status

Phase-Out Begins for AGI Less Than . . .

Individual

$75,000

Head of household

$112,500

Married filing jointly

$150,000

 

 

 

 

 

If a taxpayer’s AGI exceeds the above-referenced threshold, the taxpayer’s eligible child tax credit over the typical amount of $2,000 would be reduced by $50 for every $1,000 of income over the threshold. For those taxpayers above the threshold, the amount of the credit can be calculated as follows:

Base amount – (the number of $1,000 increments the taxpayer is above the limit [e.g., 5 increments if they are $5,000 over the limit] * $50)

For example, a married couple filing jointly with a 4-year-old, a 7-year-old, and a 10-year-old and an AGI of $165,000 would be eligible for a base amount of $9,600 ($3,600 for the 4-year-old and $3,000 each for the 7-year-old and 10-year-old). Because they are $15,000 over the AGI limit, their credit can be calculated as follows: $9,600 – (15 * $50) = $8,850

Please note: The standard $2,000 credit is still subject to the typical phaseout of $50 for every $1,000 over the threshold of $400,000 for joint filers and $200,000 for single filers.

Taxpayers may receive an advance on their child tax credit in multiple installments beginning in July 2021. It is important to note that, unlike the direct stimulus payments, the advance of child tax credit amounts would need to be reconciled on the taxpayer’s 2021 tax return and could result in a liability for a return of any credit received that was in excess of their eligibility based on their 2021 tax return.

Additionally, the Child and Dependent Care tax credit, which provides tax credits for eligible childcare expenses incurred, will have expanded income eligibility and a higher potential credit amount during the 2021 tax year under the Act.

Another tax credit that has expanded eligibility under the Act is the Earned Income Credit (EIC). Individuals and couples without children, as well as younger individuals (as young as 19), could see access to a much higher EIC than was previously available.


Subsidized COBRA Benefits

Former employees who had their employment terminated and are eligible for an extension of their employee-sponsored health insurance under COBRA will not be responsible for health insurance premiums under COBRA from April until September 2021. Instead, those premiums will be paid by the former employer, and the employer will receive a refundable payroll tax credit. There will be a 60-day enrollment period for individuals to elect COBRA coverage, and eligibility for coverage would extend to individuals who lost their employment as far back as November 2019.


Student Loan Forgiveness

The Act also changes the treatment of student loan forgiveness to be nontaxable through 2025. In the past, President Biden has expressed a desire to forgive $10,000 in student loan indebtedness for each borrower, so experts theorize that this provision may be an anticipation of future executive and/or legislative action to forgive a portion of existing student loans.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

###

McCarthy & Cox Retirement and Estate Specialists LLC is located at 127 W. 5th Street, Marysville, OH 43040 and can be reached at 937-644-0351. Securities and advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a Registered Investment Adviser.  © 2021 Commonwealth Financial Network®


2021 Market Outlook

Most annual market outlooks involve outlining potential risks that could send stocks lower – geopolitical tensions, political upheaval, an overly aggressive Federal Reserve – and in fact, our 2020 outlook featured these very items. What it didn’t mention was a global pandemic that would bring everything to a screeching halt.

Covid-19 was unlike anything we have previously seen. Entire industries were shut down. Unemployment skyrocketed. Restrictions kept people homebound. And obviously, the economy suffered huge damage. Only recently have we started to see real signs of recovery.

And while Covid-19 is still spreading, several vaccines are becoming widely available. But how do we bridge the gap between now and widespread immunization? No one knows how best to do this, but at least we have a timeframe for things to return to whatever the “new normal” is.

The economy ebbs and flows. There are good times and times when things aren’t so good. These “good” times and “bad” times fluctuate around some long-term average, much like the temperatures fluctuate between milder in the Summer and colder in the Winter each year. Unless you live in Ohio - we simply fluctuate from cold to colder with a few weeks of warmth scattered in… This is known as the business cycle.

When things are good, consumers invest more because they feel confident about the future. We purchase a new car, dine out more, or take an extra vacation. Companies may recruit new staff, build new buildings, invest in technology, etc. to create more products and services. Their expenses go up, and these expenses are passed on to consumers. Consumers slow their spending at some point, and companies cut prices to get rid of excess inventory. They may also lay off workers and sell some of these new buildings. When we hear about this, we aren’t so confident about the future anymore.

Typically, it takes years for an economy to go through an entire cycle, but we went through much of it in early 2020 alone. We had been in “good” times for a decade, but the pandemic changed that quickly, throwing us into a recession. Just as quickly, however, governments and banks around the world intervened, pushing us back into the early phase of a new business cycle. And the last time the US economy was in early cycle was after the 2008-09 housing crisis – which only recently ended with the pandemic.

There is already a lot of money sitting on the sidelines, considerably more than at the end of the housing crisis. And with savings account and CD rates where they are today, investors may be inclined to put that money to work in the equity and fixed income markets.

There are several themes we'll keep an eye on as we move throughout 2021. How these play out will likely have a lot to do with how the markets perform this year:

  • The road to recovery will likely be uneven.
  • Accordingly, how do we position portfolios?
  • With rates close to historic lows, where do we find income?
  • And finally, what impact will Covid-19 have on the remainder of 2021?

It is likely that the road to recovery will be uneven; a scenario where stocks go up in a straight line without any pullbacks is difficult to imagine. Although the recovery is focused on favorable fundamentals, there are plenty of risks that could turn things south in a hurry, and there is certainly "headline risk". After all, few had heard of COVID-19 at this time last year. An uncontrollable resurgence of the virus is among the threats that we think should most worry equity investors. We have recently heard about virus mutations. And even though we have several vaccines, it could take longer than planned to deploy them to enough of the global population to dampen the spread of the virus. All bets are off if major issues arise with the vaccines.

Rising inflation is another possible risk that is not getting any attention. Although our base-case scenario is not a rapid price spike, the ingredients for an inflationary surprise are present. The amount of liquidity that monetary stimulus offers is staggering. The level of the Federal Reserve's balance sheet compared to gross domestic product (GDP) peaked at just over 26 percent in the years immediately after the housing crisis. It was 40 percent this past June. As the Fed sits on the sidelines, if economic activity gains too much traction, prices may easily outrun attempts to rein in them.

In March, global central banks poured USD 4 trillion into the world financial system and have since added more. This year, the United States alone is forecast to run a deficit approximately equal to one-fifth of the gross domestic product. Although it may have been appropriate for this drastic degree of assistance, it is obviously not sustainable. It is unclear how and when the withdrawal of this underpinning would play out.

These are just a few of the many risks in the year ahead, and we will certainly be looking at another year of increased volatility as these ebb and flow. One of the things we were most convicted of when we entered 2020 was frequent rebalancing to take advantage of increased volatility, and we still feel that way. Rebalancing is a crucial but perhaps undervalued aspect of portfolio management, the significance of which has been highlighted by the extreme volatility of the market in recent quarters. Moreover, it is an automatic way to take advantage of the mantra "buy low sell high." We believe that, precisely when volatility spikes, active managers can add significant value.

What else can we do to take advantage of potential opportunities, besides frequent rebalancing to take advantage of increased volatility? We will look closely at value stocks, smaller capitalization firms, and equity and bond markets in emerging markets.

In equity investing, growth and value are two fundamental approaches, or styles. Growth investors are looking for businesses that offer strong growth in earnings, while value investors are looking for stocks that appear to be undervalued on the market. Since the two styles complement each other, when used together, they add a layer of diversification.

One of the biggest disparities ever between growth and value strategies occurred in 2020. And while growth and value tend to have prolonged periods of varying performance compared to each other, the length of the 2020 cycle was uncharacteristically long. Many of the winning stocks were those that provided technology to work from home, telemedicine, online learning, e-commerce, video streaming and social networking when the pandemic hit. The gap between growth returns and value companies was further strengthened by this. Because of this, relative to their growth counterparts, many value stocks became extraordinarily undervalued.

More recently, signs of a rotation back to value have occurred. Much of the underperformance of value earlier in the year can be attributed to the fact that the financial and energy sectors accounted for a substantial proportion of the S&P 500 and that both sectors were severely lagging during the shutdown. Value stocks have begun to shine as the global economy has re-opened, as they tend to do well early in an economic recovery.

Small cap stocks are also favored by the early cycle environment. The recession is likely over, which means we are in the early stages of a new business cycle, and a new bull market. In comparison to their large cap counterparts coming out of recessions, small caps have historically performed well. The tale is the same as coming off major bear market lows where, on average, during the first year of bull markets, small caps outperformed large caps by about 15 percent. True to form, small caps have outperformed large caps by more than 10 percent since the March 23 low.

In 2021, Emerging Markets equities will also benefit from a cyclical global upswing and the Biden administration's more predictable U.S. trade policy. Investment flows into Emerging Markets equities should underpin these variables. Also, while China and parts of Asia were initially the hardest hit by the pandemic, they were also the first to recover and, when restrictive measures were lifted, saw remarkable rebounds. While at some point this momentum may fade, governments will continue to provide support. Given the accommodative environment, both emerging market equities and fixed income appear attractive, which is a nice segue to the next area of focus: where do we find income with today’s rates?

Questions are rightly being asked about the effectiveness of bonds as a hedge for equity risk. This has become more valid as the prospect for an offsetting rise in bond prices diminishes when yields have little room to fall further. Bonds still offer relative capital stability, however, and at lower maturities where duration risk (sensitivity to changes in interest rates) is smaller should continue to offer income without excessive capital volatility.

For investors concerned about the impact of low interest rates on Treasuries, diversified core fixed income can still act as portfolio ballast in volatile markets. In simple terms, investors could lower credit risk in an area with lower return potential like short-term bonds, which may help balance higher risk in an area with higher return potential, such as floating rate bank loans.

This ballast allows us to seek out opportunities within equities, namely the prime potential beneficiaries of the economic recovery, such as emerging market equities and US small caps. Additionally, with interest rates likely to remain low and rangebound, we can look for opportunities in other non-core areas such as credit and emerging market debt. Emerging markets bonds, both government and corporate, have attractive yields and should benefit as accommodative monetary policies enhance global liquidity.

And how will Covid-19 and Geopolitics affect 2020? You may be reading this from a home office or temporary workspace that is starting to feel permanent. You may also be working odd hours to accommodate a child’s remote school schedule. You are probably wearing casual clothes nice enough for video meetings and answering your door to accept deliveries of food and other online purchases.

Eventually, we will return to something we consider normal, but some of the ways we learn, work, shop and entertain ourselves will never be the same. This transformation played out in various investment themes in 2020, and we will likely see some of them carry over to 2021.

An ongoing pandemic, a weakened economy and a deeply polarized country are facing President-elect Joe Biden. A more predictable U.S. approach to trade, foreign affairs, and working with allies is the principal geopolitical implication. It is likely that tensions with foreign countries will ease, especially over trade. The markets should be helped by this, as well as US support for multilateral debt relief efforts.

In summary, we believe 2021 is shaping up to be amicable to stocks. However, equity market gains may become more dispersed as we work through the recovery. As its adoption has been accelerated during the pandemic, technological innovation should contribute to equity returns. And many of the areas that lagged during the pandemic should rebound as we move towards a full, global reopening. Leading companies may emerge from the crisis in an even stronger position as they seek acquisition targets and capitalize on competitor missteps.

To be certain, the economy and markets could be affected by another wave of Covid-19. Nor is the coast clear for a regulatory environment that is business-friendly or a resumption of unfettered global trade. However, considering the nature of this downturn along with the performance of the global economy well before the pandemic, we can look back to 2020 as the advent of a new bull market cycle, the last five of which have lasted over five years each.

When fear and uncertainty are high, markets go down. The reverse is also true. Each day brings us closer to the end of the pandemic and closer to a more certain future, one where we can hopefully find some semblance of normalcy. As such, we will view any pullbacks as buying opportunities, making modest bets around our long-term, strategic allocations. As always, a diversified portfolio and long-term view still offer the best route to reach financial goals.

- The McCarthy & Cox Team
Authored by Wes Bean, Director of Investments


Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged, and investors cannot invest directly into an index. Market references refer to the S&P 500 Index, a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. Fixed Income or Bond market references refer to the Barclays Capital Aggregate Bond Index. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.

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