The S&P 500 had its best month since April, gaining 7.19% in value during August and breaking to new all-time highs. Of course, the main difference between April and August is that April’s return came on the heels of a sharp bear market, whereas August’s enormous gain came on the heels of… other months of enormous gains. The index is now positive year-to-date by 9.74% and has gained 21.94% over the trailing twelve months. After taking a breather earlier this summer, growth-style stocks have resumed their historic lead over value. Year-to-date, the S&P 500 Growth index is positive by 26.53% while the S&P 500 Value index is negative by -9.3%-- a difference of 35.83%! This is unprecedented. Since the two styles had their own indexes beginning in 1995, the greatest disparity in a calendar year was in 2000, when value outperformed growth by 28.16%. In fact, the year 2000 offers a valuable lesson for investors thinking about dumping their value holdings, as it represented a huge reversal from the growth-led market that culminated in the dot-com bust. This environment is different from the tech boom of the late 90s for many reasons – most notably the proven worthiness of today’s tech leaders, as well as all time low interest rates – but the lesson is still worth heeding.

So, what caused the strong returns of August? It was a continuation and improvement of the favorable conditions from the previous month. We wrote last month that second quarter corporate earnings were providing positive surprises on a historic scale, not only in terms of the number of companies reporting positive surprises, but also the average size of the surprise. With 98% of companies in the S&P 500 having reported by the end of August, that rosy picture has slightly improved with companies reporting average earnings 23.1% better than the estimates, according to FactSet. The market was also pulled forward by the strong returns of its largest contributing constituents. We have written previously about the outsized impact of the FAANG + M stocks (Facebook, Apple, Amazon, Netflix, Alphabet or Google and Microsoft), which now make up more than 20% of the S&P 500’s market capitalization. Each of those companies had very strong returns in August, with Apple and Facebook leading at 21.6% and 15.6%, respectively. If that were not enough, some positive news related to COVID-19 reinforced the notion that the pandemic will cease to be a source of disruption soon. Abbott Labs got emergency approval for a $5, 15-minute antigen test which will boost rapid testing efforts and enable still-depressed parts of the economy to consider relaxing restrictions. Meanwhile, the likelihood of a vaccine being approved by the end of 2020 appears to be increasing.

Perhaps the most notable news of the month came at the end, with much of the strong returns having already occurred. On August 27th Jerome Powell, Chairman of the Federal Reserve, announced a significant shift in policy emphasis for the central bank. It had previously been the Fed’s posture to ward off inflation above 2% by anticipating a rise in price data and preemptively raising rates. Powell explained that the Fed will now allow inflation to tick higher than it normally would in order to support the economy. Though this point may seem nuanced to the average investor, it is a remarkable shift that will almost certainly give investors confidence that cheap lending will be around for longer. While the stated reason for this shift is the need for support during these unique economic times, one can’t help but wonder if the Fed is also acknowledging that inflation hasn’t really posed a threat in the past decade with historically low rates. Interest rates are by no means the only driver of inflation—technological innovation and globalization also do a lot to keep prices low—and the Fed may be recognizing the full extent of these factors. Whatever the underlying motivation, markets now expect rates to stay at zero for the indefinite future.

It will be interesting to watch markets absorb this slate of positive news as we now only have two full months between us and the 2020 Presidential election. Market volatility and election uncertainty have historically gone hand in hand, but we have not seen that yet in this cycle. How will investors react to the possibility of a Biden presidency, perhaps even with a full Democrat sweep of the House and Senate? Whatever your political leanings, Biden’s proposed tax changes pose, at the least, some short-term threats for the market. In addition to raising the rates for those in the highest income bracket and bumping the corporate rate from 21% to 28%, Biden has also proposed replacing the lower capital gains tax rates with the rule that realized gains will be taxed at higher ordinary income rates. If such measures were to pass, they would likely take a lot of wind out of the market’s sails. Still, some notable market watchers believe a Biden win would be good for the markets in the long run, as it would signal a return to a more conventional, institutional-based style of politics.

At the risk of repeating ourselves, we stress the importance of using this period of strong market sentiment to evaluate your portfolio and make any necessary changes. Even if you feel like you are targeting the appropriate amount of risk, consider rebalancing your portfolio now as it is likely that the growth investments have grown far out of proportion to their value counterparts. If there is a rotation from growth to value, you will be better positioned to perform well if you take some of this years’ growth profits off the table and bring your allocation back into line.

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