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Eureka Wealth Solutions November 2020

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Quote Of The Month

The light at the end of the dark virus tunnel is now shining a lot brighter... Yet we are not at our destination. The next few months have a material impact on our longer-term well-being.

-- Mohamed El-Erian, the chief economic adviser at Allianz

Economic Highlights

  • The COVID-19 second wave is causing spikes in new cases and new lock-downs pressuring the economy and healthcare system. The vaccines are almost ready for distribution, however, and offer substantial hope of the light at the end of the tunnel.

  • Consumer spending, real business equipment spending, and housing activity all continued to recover with relative strength.

  • Payroll employment recovery of lost jobs has slowed down, especially in leisure and hospitality industries.

  • Massive fiscal support has boosted debt and deficits.

  • The COVID-19 second stimulus package is still stuck in Congress.

Market Highlights

  • US Equities enjoyed a huge relief rally in November, as expected, and S&P 500 Index closed up 11.0%.

  • Foreign equities also rallied, with Developed Markets up 15.5%, in a rare display of out-performance, and Emerging Markets also up 9.3%.

  • US high-grade bonds added up 1.0%, while the high yield joined the risk-on rally and added 3.8%. Foreign high-grade and high-yield bonds also rallied 4.0% and 6.8%, respectively, and Emerging Markets bonds added 3.6%.

  • Commodities edged up 3.5%, helped by a giant leap in oil, up 27.0%, while gold gave up -5.3%.

  • US Dollar resumed its slide, down -2.3%.


 

Observations and Expectations

With the multiple Election risks seemingly all but resolved, the markets pushed higher across the board in November. The apparent closeness of an effective and affordable vaccine distribution certainly helped as well, as did the largely netter than expected corporate earnings. The SPACs we mentioned last month have been feeding the insatiable appetite for new issues, almost regardless of the risks. More on this in or Question of the Month.

Looking forward to December, we’ll be watching whether the lame-duck session of the Congress can make some progress on the pandemic stimulus package and avoid the government shutdown. Absent any other significant political, economic or medical news, we expect the markets to continue drifting higher, ignoring the near-term alarming coronavirus numbers and looking ahead to the eventual recovery, which remains far from guaranteed.

We’re continuing to look for many market and innovation trends, as thematic investments are beating traditional market indices by leaps and bounds in 2020. The green energy and green transportation, in particular, are having a moment of investment euphoria. At the same time, a major market rotation out of the stay-at-home names into cyclical industries quietly benefits the traditional energy, among other industries. We also see value in broader healthcare, as the markets seem to finally recall that it includes more than the COVID-19 vaccine companies. Some parts of the market are beginning to resemble the Internet bubble of the late 1990’s, although occasional pullbacks, broad leadership, sector rotation, low rates and long-term momentum and sentiment point to the likely continuation of the overall equity rally in the foreseeable future. Many analysts point out the relative value that the foreign and especially Emerging Markets equities appear to present, although we believe investors should remain very selective there.

Sector Update

Real Estate is once again feeling the effects of the pandemic during the latest surge in the infection numbers. While other cyclical centers are trying to look past the current difficulties into the future, the worries about the real estate persist, especially around potentially irreversible structural changes the commercial, hospitality and retail sub-sectors. Once again, we urge investors to be very discerning in this area rather than relying on the broad passive indices that carry significant weights in the three areas mentioned above.

Energy sector has been a perennial loser for the last few years and especially this year, when you refer to the traditional oil & gas kind. Yet November marked a remarkable turnaround, handily beating every other sector by double digits. The VanEck Vectors Oil Services ETF (OIH) gained 44.1% for the month of November, while the Energy Select Sector SPDR Fund (XLE) rose by 28.0%, $WTIC Light Crude Oil (USO) prices gained 26.7%, $BRENT Crude Oil (BNO) prices gained 26.2%, and the Alerian MLP ETF (AMLP) increased by 23.5%. Oil demand has already outpaced supply in Q3, and that trend is now extending. The meteoric rise in alternatives also helps oil demand and price, which is an often misunderstood market dynamic. Many analysts consider a bet on oil right now to be a pure-play bet on the global economic recovery.

Impact Investing is continuing an historic year after the tipping point has been reached. November saw another strong inflows into overall US ETFs ($90B), of which $7B went into thematic impact funds – see below.

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Question of the Month

This is where we answer the best investment question we’ve heard all month. If you’d like your question to be considered, please send it to us.

Question

What are SPACs and why are they suddenly hot?

Answer

SPAC, which stands for a special purpose acquisition company, is a “blank check” shell company that exists for the sole purpose to take companies public without going through the traditional IPO process. According to the SEC, they are created specifically to pool funds in order to finance a merger or acquisition opportunity within a set time-frame, which is usually has yet to be identified.

So how does it work? Essentially, an asset manager tells investors, “Look, I see some opportunities in the private markets. I’m an expert and if you lend me some money, I’ll make it worth your while.” SPAC issues an IPO, which is as transparent as can be because it’s all cash. For example, they can raise $300M and issue 30M shares at $10 each. After that they go hunting for private companies. If they’re able to find a suitable target, they complete a merger, in which case the SPAC shareholders get shares in the target company, effectively taking it public. If no suitable target is found within allocated time-frame, as specified by its charter, the SPAC dissolves, returning the original investment to its shareholders.

So how is that different from IPOs? Actually, in two very important ways. First, it allows the private company to bypass the scrutiny of the regulators and initial public investors that comes with IPO filing. It also saves time for investors and money for the target company, the insiders of which can typically also forgo the usual IPO lockup periods. The SPAC IPO has no complexities and its merger/acquisition only goes through a formality of a paperwork due to the nature of the shell corporation, although the SEC still must review and approve both. That is simultaneously the point of a major advantage and a target of a major criticism of SPACs. It also brings us to the second point: SPACs allow retail investors to invest in private equity type transactions, without paying high fees and avoiding all usual minimum investment and holding time restrictions. Investors also don’t need to worry about the exclusive nature of a typical IPO process, which most retail investors can’t get access to, not to mention fretting the downside risk.

SPACs have been around since the 1990’s but were an obscure form of an investment. They started a surge a few years ago, growing from $1.8B across 12 SPAC IPOs in 2014 to $13.6B across 59 SPACs in 2019. The number and value of SPACs exploded in 2020, with each consecutive quarter marking a new record. There were 77 SPAC IPOs in the third quarter alone, an increase of 185% compared to the 27 that debuted in the second quarter. The SPACs tended to be in the $100-$500M range; however, the largest SPAC IPO of 2020 is worth $4B. Gross proceeds for the quarter totaled $28.8B—more than double the money raised in the second quarter. The success or failure of this large class of SPACs likely determines the survival of this trend.

So why now and what makes SPACs hot? SPACs have remained popular notwithstanding the COVID-related market disruption, perhaps because of the flexibility of SPACs to pivot to attractive industries based on changing market fundamentals and sentiment, in addition to the reasons already mentioned above. And with 2020 being the year of a pandemic and a charged election, there was less incentive for companies to take on even more risk than the already inherently risky IPOs. The rise of the so-called “new retail investors” aka Robinhooders also helps facilitate an out-sized demand to get into those attractive industries both for the quick turnaround trade as well as for the long-term investment. Some of the themes that have received the highest investor demand when it comes to SPACs in 2020 include:

  • Electric and autonomous vehicles and supporting industries such as battery makers, charging stations and car sensors
  • Fintech
  • Health Tech
  • Green Energy
  • Online Gaming
  • Cannabis

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The materials presented above serve informational purpose only and do not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. The author, Eureka Wealth Solutions, LLC, and/or its clients may hold positions in the ETFs, and/or any investment assets mentioned above. Folio portfolios that may be presented are created by Eureka Wealth Solutions, LLC, and are available for purchase through Folio site.  Indices and trademarks are the property of their respective owners.  There are risks involved in investing including possible loss of principal.  Performance results of individual securities and portfolios are not indicative of overall client account performances. Past performance does not guarantee future results.
 
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