Coming into 2020 the U.S. economy, as we measure it with the Astor Economic Index®, was growing about trend, though weaker than the pace of 2018. The U.S. consumer was the true pillar, with the unemployment rate sitting at 3.5%. U.S. Manufacturing had peaked in the second half of 2018, declining steadily through 2019 as the U.S./China trade war took its toll. The broad picture when the Covid-19 pandemic began was modestly slowing manufacturing and a solid consumer. As a result of this somewhat tepid rate of growth Astor’s portfolios trended toward the middle of their risk range at the beginning of 2020, portfolios balanced between return seeking and defensive.
To recap briefly, in March 2020 the U.S. entered a state of economic suppression, not a traditional recession. 22 million Americans lost their jobs at least temporarily. The consumer went from being a source of strength to a weak spot overnight. The speed and magnitude of declines in the broad economic data was unprecedented. The Astor Economic Index® digested the data of the pandemic’s early phase and moved decisively away from risk assets early in the second quarter.
After the initial shock of Q2, the data began to regain its footing. U.S. payrolls are nowhere near their pre-pandemic levels, but after losing 22m jobs initially, over 12m workers have been added back. Manufacturing and (to a lesser extent) service economic output has bounced back. Because the Astor Economic Index® is oriented toward picking up changes, it has registered a substantial rebound in economic activity leading to additional equity exposure in the portfolio.
Reconciling 2020 and the Pandemic
At Astor, we think that the market’s reaction to any external shock will be in part related to the economic situation going into the event. A market decline when the underlying economic conditions are poor is, in our opinion, unlikely to be quickly reversed. On the other hand, a misbehaving market at a time when the economic situation is stable is much more likely to find support and recover.
We believe that by systematically having an economic lens on investing we can add value in the long term through risk mitigation. The efficacy of our philosophy, while not infallible, we believe is supported by decades of research and real time implementation. The premise of our approach is that we want to extract regularities from the history of the interaction of the markets and the macroeconomy.
What lessons do we draw from the 2020 experience? Rarely, there are events which are impossible to anticipate and the inability to take those into account in a systematic strategy may seem like a weakness, but it is also a strength. For example, by having an economic index oriented toward the change in economic output, not the level, we were led to quickly add exposure to equities as the changes turned positive this year even as the levels of the economic variables remained quite low.
Should Astor have built in the chance of a pandemic into its model? Without any opportunity to evaluate how it has affected the economy and hence the market it would have as fruitless as modeling Godzilla rising from Tokyo Bay to lay waste to Japan. We take the stance that shocks will feed into traditional economic statistics and that is best way to handle them.
If we cannot or choose not to add something systematic to the strategy, should we be using more discretion in events like the lockdown? Importantly, Astor’s Investment Committee always reserves the right to reduce risk in our portfolios in the event we feel like our models are not adding understanding. To a large degree, we didn’t do this in March because we thought that our models were reasonable, all things considered. Looking back, we cut exposure a great deal, but did not put on the inverse equity trades which are the hallmark to our severe recession response. We continue to think that cutting equity exposure close to zero was an appropriate response given what we knew on say 4/15/2020.
But to emphasize again: our duty is to protect our client’s capital. If we were in a situation where we believed some of our traditional indicators were not going to match with the current reality at all, the investment committee could imagine taking more drastic action in the direction of cutting equity exposure toward zero. Currently, however, we believe we have the balance right in our economic models and more importantly in our portfolios. No portfolio manager can afford to waste a crisis to better understand the market, so what have we learned? One thing is to be more mindful of the high frequency data to get us a bit ahead of the monthly or weekly data we have normally relied upon. Research on this topic is ongoing.
Managers always talk about how hard it is to predict what will happen next year, but I think this year we can be forgiven the cliché. There are a few countervailing forces at play for the next year. On the positive side we calculate that there is perhaps $1.5 trillion in excess household savings right now along with very solid household balance sheets. Couple these with the very good vaccine news we have had so far, and we could have the makings of a Biden Boom or at least a Biden Bump in 2021. On the other hand, we still have 10 million fewer workers employed than a year ago, industrial capacity utilization is far below normal, and we do not know how much of the service sector disruption of the last 9 months is permanent. Enough clouds to lead to a Biden Bust.
At Astor we believe that now it is more important than ever to be looking at the economic data with a rigorous framework, not to trade off the greed and fear inspired by contradictory headlines. As we close 2020 we have a fairly optimistic view on the economy, but we will be carefully watching for signs of backsliding.
The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.
All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information. There is no assurance that Astor’s investment programs or funds will produce profitable returns or that any account with have similar results. You may lose money. Past results are no guarantee of future results and no representation is made that a client will or is likely to achieve results that are similar to those shown. Factors impacting client returns include individual client risk tolerance, restrictions a client may place on the account, investment objectives, choice of broker/dealers or custodians, as well as other factors. Any particular client’s account performance may differ from the program results due to, among other things, commission, timing of order entry, or the manner in which the trades are executed. The investment return and principal value of an investment will fluctuate and an investor’s equity, when liquidated, may be worth more or less than the original cost. An investment cannot be made directly into an index. Astor purchases securities which contain embedded expenses. These costs result in a layering of fees. As a result, the cost of the investment strategy selected will be higher than the cost of investing directly in ETFs. Please refer to Astor’s Form ADV Part 2A Brochure for additional information and risks.