Third Quarter of 2020

It’s quite astonishing that we were on the verge of a global depression at the end of March, and today the major US market indices are near their all-time highs. The market recovery is difficult to understand while so many people are out of work, small businesses are closing, restaurants are struggling, and US air travel is down more than 60% from year ago.

There are a number of reasons why the markets have been able to rebound, including the following:

1. A massive increase in liquidity. The Federal Government rapidly approved a $2 trillion stimulus plan, which has helped small businesses, airlines, and the unemployed, amongst others. The Federal Reserve cut interest rates to zero, purchased bonds, and said they will do whatever it takes to support the economy.
2. 
   As interest rates and bond yields approach zero they provide a minimal return to investors. The continued decline in interest rates has made US stocks more attractive relative to bonds. The yield on the 10-year US Treasury Bond is about 0.70% versus the current dividend yield of 1.7% on the S&P 500. Additionally, as interest rates have declined, the discount rate to value stocks has declined, which equates to higher multiples for stocks.
3. 
   The market prices stocks based on future outlook and not on earnings that companies are expected to generate in the current year. Every day we move closer to a vaccine and new therapeutics. At some point, life will return to something resembling normal as it historically has done after other viral pandemics. There is pent up demand for travel, dining out, and other social activities.
4. 
   Finally, the pandemic has accelerated certain trends such as digital transformation, and technology stocks have benefited from this. Technology stocks are the best performers this year and they also have the largest weighting in the S&P 500. The 5 largest stocks in the S&P 500 (Microsoft, Apple, Google, Amazon, and Facebook) are up 42% and the other 495 stocks are down 2%.

2020 has been a rollercoaster ride for the markets and exemplifies the pitfalls of trying to time the markets. The below chart shows how missing some of the best market days can impact your long term returns.

Image Source: Strategas Research Partners

On almost everyone’s minds is the upcoming presidential election in November and how the election outcome might impact the markets. As we write this, Trump has tested positive for the coronavirus and Biden is ahead in the betting odds and the polls. In fact, Biden is ahead of where Hillary Clinton was at this time four years ago, as shown in the chart below.

Image Source: Strategas Research Partners

We expect volatility to be elevated around the election. We don’t think it matters to the markets if Biden or Trump wins. If Biden wins and the democrats win the Senate, it could be incrementally negative because of Biden’s plan to increase taxes, but that increase would be more than offset by fiscal spending.

The most important thing to the markets is the trajectory of the virus and the economic recovery. Currently, we believe the market has already discounted the possibility of a second wave in the Fall, which has started in earnest in Europe and will likely occur here as well. Offsetting this negative event is the high probability of additional fiscal stimulus as well as the release of an effective vaccine at some point early next year.

Ultimately, market volatility around the virus and the election could present opportunities to further improve our portfolios for future success. We have made a number of changes in the portfolios this year and are optimistic about the long-term prospects of the companies that we own.

Our Brasada US Equity portfolios and most of our Focused Equity portfolios have outperformed the S&P 500 this year. This is due, in part, to owning a number of technology and internet stocks such as Ansys, Everbridge, EPAM Systems, Microsoft, Tyler Technologies and Nintendo, among others. Pet ownership has accelerated during 2020 and these two strategies have also benefited from owning IDEXX Labs or Zoetis, both pet healthcare companies.

Our Dividend Growth portfolios are about flat on the year. They have also benefited from owning stocks such as EPAM Systems, Microsoft, and Zoetis. However, these accounts own a number of utilities and REITs, which are more directly affected by coronavirus-related changes in human activity. Some utilities such as NextEra Energy and American Water Works have been great stocks, but overall, utilities are down for the year and have been a drag on performance. We think utilities are more attractive than they have been in quite some time, and the names we own offer attractive dividend yields and are creating value as they transition to a higher mix of renewables. Some of our REITs such as American Tower, Crown Castle, Equinix, and Digital Realty have performed well, but overall, REITs are also down for the year. The REITs we own also offer attractive dividend yields and have a solid outlook. We do not own shopping mall or traditional office REITs, which we expect to be under pressure for years to come.

Finally, the Equity Income portfolios have underperformed this year. These portfolios are mostly invested in utilities and REITs. Technology and internet stocks have driven the market this year, and the Equity Income portfolios do not own these stocks since they don’t pay meaningful dividends. Almost all of our holdings in this strategy have maintained their dividend and many have actually increased their dividend payout. There are several companies that cut their dividend, but our expectation is that they will raise their payouts in the near future now that things have stabilized.

For those of you who have accounts at TD Ameritrade (TDA), there are a couple of administrative notes we wanted to bring to your attention. First, TDA is participating in a name and taxpayer identification number matching program with the IRS to help identify any differences between its custodian records and IRS records. The purpose of this exercise is to help clients rectify potentially incorrect account information at TDA before tax forms are issued in order to avoid any delays or potential backup withholding. TDA has sent letters directly to clients with additional details, but please do not hesitate to contact us if you have any questions. Second, TDA is now offering mobile check deposits for clients through their AdvisorClient Mobile App. This new option enables you to deposit checks directly to your TDA account via your mobile phone. While we can always assist with deposits as we have in the past, we wanted to bring this new option to your attention given recent, and potentially future, mail delivery and processing delays related to the COVID-19 pandemic.

If you have any questions, please contact us. We are happy to set up a zoom call or a phone call.

All the Best,

Jonathan Reichek, CFA

This quarterly update is being furnished by Brasada Capital Management, LP (“Brasada”) on a confidential basis and is intended solely for the use of the person to whom it is provided. It may not be modified, reproduced or redistributed in whole or in part without the prior written consent of Brasada. This document does not constitute an offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment advisory services or to participate in any trading strategy.

The net performance results are stated net of all management fees and expenses and are estimated and unaudited. These returns reflect the reinvestment of any dividends and interest and include returns on any uninvested cash. In addition to management fees, the managed accounts will also bear its share of expenses and fees charged by underlying investments. The fees deducted herein represent the highest fee incurred by any managed account during the relevant period. Past performance is no guarantee of future results. Certain market and economic events having a positive impact on performance may not repeat themselves. The actual performance results experienced by an investor may vary significantly from the results shown or contemplated for a number of reasons, including, without limitation, changes in economic and market conditions.

References to indices or benchmarks are for informational and general comparative purposes only. There are significant differences between such indices and the investment program of the managed accounts. The managed accounts do not necessarily invest in all or any significant portion of the securities, industries or strategies represented by such indices and performance calculation may not be entirely comparable. Indices are unmanaged and have no fees or expenses. An investment cannot be made directly in an index and such index may reinvest dividends and income. References to indices do not suggest that the managed accounts will, or is likely to achieve returns, volatility or other results similar to such indices. Accordingly, comparing results shown to those of an index or
benchmark are subject to inherent limitations and may be of limited use.

Certain information contained herein constitutes forward looking statements and projections that are based on the current beliefs and assumptions of Brasada and on information currently available that Brasada believes to be reasonable. However, such statements necessarily involve risks, uncertainties and assumptions, and prospective investors may not put undue reliance on any of these statements. Due to various risks and uncertainties, actual events or results or the actual performance of any entity or transaction may differ materially from those reflected or contemplated in such forward-looking statements. The information contained herein is believed to be reliable but no representation, warranty or undertaking, expressed or implied, is given to the accuracy or completeness of such information by Brasada.