Despite a significant increase in COVID-19 related deaths and election uncertainty, the stock market rose once again in the 3rd quarter.
For the 7th consecutive quarter, Growth stocks outpaced Value/Dividend stocks significantly, mostly due to the continued surge of large tech stocks.
While it is easy to get caught up in the election frenzy, it is best not to make investment decisions based on your political beliefs.
Although we are hopeful that COVID-19 vaccines and treatments are on the horizon, we expect the pandemic to be a drag on the global economy throughout much of 2021.
2020 has been one of the most difficult and extraordinary years in modern history. COVID-19 has now killed more than a million people worldwide and over 200,000 in the U.S. alone. As the pandemic swept the globe in the first quarter, the corresponding self-imposed economic shutdown trigged a very sharp and deep recession. While the summer months saw a bounce back in our economy, both our GDP and employment remain far below the levels we enjoyed pre-pandemic.
Changes to fiscal policy and a massive monetary stimulus have softened the impact of the recession but have also raised questions about the stability of our economy in the long-term. Political tensions remain very high in the U.S. as the country approaches the election in November. Through it all, markets have staged a remarkable recovery, leaving many to wonder whether their portfolios can continue to rise in the face of such uncertainty.
The fourth quarter should provide some answers to this question, as we get a clearer understanding of the political landscape and the trajectory of the pandemic.
Looking back at the third quarter
U.S. equities continued to rally in the 3rd quarter fueled by optimism about the path of the economic recovery. Activity picked up as businesses reopened and consumers adapted to new guidelines affecting work, commerce and recreation. Led by technology stocks, the market completed a full reversal of the bear market’s steep losses: between March 23 and September 2, the S&P 500 Index soared 61%. In the third quarter, the index advanced 9% despite choppier markets in September as investors turned their attention to the upcoming election. Large caps topped small caps, and growth stocks outpaced value for the seventh straight quarter.
Apple became the first U.S. company with a market capitalization of $2 trillion, only two years after surpassing the $1 trillion milestone. Like several other large tech companies, Apple has benefited from robust online sales and strong demand for its products and services while consumers shelter at home. Amazon and Facebook also outpaced the broader market and touched record highs in the quarter. The industrials sector climbed 12% as a surge in online shopping boosted earnings of delivery services companies such as FedEx and UPS. Energy was the only sector to decline as demand remains low, falling 20% despite a modest rise in West Texas Intermediate oil prices. The sector is down 48% year to date.
International markets fared well
Developed international market equities also had a strong quarter, gaining 6%. Similar to domestic markets, growth stocks outperformed value and dividend stocks. Returns were aided by a falling US Dollar during the first few months of the quarter and will continue to benefit if the dollar shows further weakness.
At this time COVID cases are rising throughout Europe and some countries have moved to localized shutdowns. This is certainly something to watch, but valuations across the developed international landscape continue to be attractive versus their US counterparts.
Emerging markets fared better than developed markets gaining 9% for the quarter and almost reached pre pandemic levels. China has seen a very strong economic recovery and will most likely be the only major world economy to have positive GDP growth in 2020. Due to various geopolitical risks, emerging markets tend to be a volatile investment class, but with inexpensive valuations, tailwinds of a younger consumption demographic, and government infrastructure spending, we see opportunity in coming years.
As a reminder, our alternative investments are comprised of positions that are distinctly different from traditional equity and fixed income. Real Estate Investment Trusts (REITs) were up 1% for the quarter. Much like the S&P 500, REITs have had bifurcated performance this year with real estate focused on data centers and infrastructure up strongly while retail and commercial office real estate have lagged considerably.
Emerging markets debt was up 2% after a very strong second quarter. In a world where it is difficult to find yield, EM debt offers an attractive 4% yield. Towards the end of the quarter we added a natural resources fund to our alternative lineup which consists mainly of exposure to metals, agriculture and energy. Historically this asset class has had a low correlation to our other holdings, which should help smooth returns over time.
Checking in on Fixed Income
Bond markets turned in another quarter of gains as some economic data showed the U.S. economic recovery grinding on, despite challenges tied to the pandemic. The Fed adopted a new 2% average inflation framework that allows for higher periods of inflation in an effort to support the labor market.
The new policy effectively signaled that interest rates will likely remain low over the next few years. It is important to recognize the Fed’s willingness to buy almost unlimited quantities of Treasuries; this is enabling the Federal Government to deploy the most aggressive fiscal stimulus since World War 2 to support of our recovery.
Looking Forward: The Election and COVID-19
It is always a good principle not to let how you feel about politics cloud how you think about investing. Many republicans assumed the stock market would go down under President Obama and many democrats assumed the market would fall under President Trump; both lost money on those bets and possibly harmed their financial plans in the process.
Given the closeness of the polls, the uncertainty caused by the electoral college and the problems of voting during a pandemic, the election results are currently too close to call and likely won’t be determined until sometime after election day on November 3rd.
While initially the market may react positively or negatively, regardless of the result, the stock market is likely to continue to rise over time as it has for the last 70+ years amidst a variety of political scenarios including divided governments and when one party controls both sides of Congress.
As we have noted in prior communications, we believe the social, legislative and medical response to COVID-19 will drive the economy and stock markets much more than the election. We hope and believe that the development of vaccines and treatments in late 2020 and 2021 will allow us to reduce new infections to levels where testing, tracing and isolation can keep the general population safe and permit a return to normality. This process is likely to take most of 2021 to be achieved, and consequently the pandemic will likely still have dragging effects on economic activity throughout next year.
Currently analysts are forecasting corporate earnings to reach an all-time high in 2021 which we believe is a little too optimistic. While many businesses can operate and thrive in a pandemic such as technology companies, there are many that either could operate below capacity with careful protocols in place or simply cannot operate at all.
We believe as companies release their earnings and forecasts in the coming weeks, analysts are likely to adjust down their estimates for 2021. That being said, we do expect earnings to rebound strongly in 2022, possibly to new highs. This supports the idea that the sharp selloff from early 2020 was overdone. Remember, in theory stock prices represent the present value of all future earnings. And if earnings do recover as we expect, the ultimate impact of the pandemic on stocks prices should be modest in the long run.
During periods of extreme uncertainty and fear, it is natural for investors to make knee-jerk decisions out of a desire to protect themselves, their loved ones, their businesses, etc. If you are considering a major financial change in the coming weeks or months, please let us help you work through these decisions. We are here for you during these times.
We truly appreciate the trust you place in us, and we wish you and your families a safe and enjoyable holiday season.