THIRD QUARTER 2020 COMMENTARY
DATE: October 1, 2020
FROM: David G. Dietze, JD, CFA, CFPTM, President and Chief Investment Strategist
Fritz Schoenhut, MST, CFA, Managing Director and Portfolio Manager
I. Performance Update
• After an incredibly strong second quarter, equity markets continued to post solid returns into the summer months. Through early September, the S&P 500 was up over 15% for the quarter, over 12% on the year, and completed the full recovery plus more as the index moved up through its pre-Covid highs. This continuation of the second quarter’s strong growth on the back of historic monetary and fiscal measures to curb the economic impact of the coronavirus hit a wall in the final month of the quarter. Equities pulled back from what many perceived as frothy valuations led by some of the largest tech names, which resulted in value stocks outperforming growth by 3.5% for the month. The S&P 500 ended September down 4.5%, bringing its quarterly return to a still strong +8.9%.
• Why the rollercoaster ride? The massive stimulus continued to work its way through the economy, helping to bolster an economic rebound that began in the second quarter. Additionally, Jerome Powell and the Fed continued to telegraph the inclination to keep rates lower for longer. Equity markets received an additional jolt when it was announced that the Fed would even consider allowing inflation to run above its long-term target. It appeared easy to be bullish on equities given such accommodations, strong expected earnings comparisons for 2021, and the assumed additional stimulus package that was believed to be approved prior to the election.
• This complacent feeling was short lived as it became apparent late in the summer that any additional stimulus package would be difficult to pass through a Congress of two divisive parties in an election year. As a result, after months of risk assets posting strong returns and equity valuations continuing to expand, investors pulled back as big tech like Tesla (TSLA) and Apple (AAPL) fell sharply in September, and the market notched its first negative month since March. Though the quarter ended on the upswing, major questions and hurdles still face investors, not the least of which is the upcoming Presidential election and the potential for a resurgence in Coronavirus cases.
• The major market indices exhibited their top quarterly performances in several decades. The Dow gained nearly 18% (best since 1987), the S&P 500 gained 20% (1998) and the Nasdaq moved up 30.6% (1999). While Tech stocks once again were near the top of the pack, the market was led by the Energy and Consumer Discretionary sectors, up 31.9% and 30.5% respectively. This is due in large part to the risk-on sentiment that catapulted the market following the end of the first quarter. Holding on to the hopes that the global slowdown and quarantines would not be long lived, investors piled back into the positions that were shunned by the Stay-At-Home trade.
• Financials continued to underperform the market, up “only” 11.85% for the quarter, as interest rates remain near historic lows. The Fed has not wavered in its desire to keep rates lower for longer, at least into 2021 and until more certainty on the path of the recovery is clear, which will continue to compress banks earnings potential. If a recovery is to take hold, do not discount the power of the US consumer, now flush with stimulus cash. Signs of inflationary pressures could lead the Fed to reconsider its stance on low interest rates, a potential boon for bank stocks. However, with global interest rates at 0% or lower, the odds of this scenario remain low for now.
• Once again, the market was led by the Consumer Discretionary sector, up over 15% for the quarter. This is due in large part to the continuation of the risk-on sentiment witnessed in Q2 as the fear of the virus abated over the warmer months as well as a bounce back in retail sales, especially among those able to take advantage of e-commerce and at-store pick up. The other big winner for the quarter was the Materials sector, up 13.5% as investors weighed the odds of a bounce back for the global economy.
• Energy lagged this quarter, underperforming the market and finishing the three months down 19.5%. The sector was trading flat through the first half of the quarter before falling precipitously, possibly as a result of investor focus on the election and the potential for regulatory shake up should Biden win the White House.
II. Looking Forward
We continue to remain cautiously bullish as we head into the fourth quarter. Similarly, there are reasons to pull back from the markets. Election uncertainty and the Coronavirus are ever present in the minds of investors and will surely keep volatility elevated. That said, historically, elections have not been good indicators of when to underweight within your portfolio. The 2016 election is the most recent example of how wrong many can be, not just predicting outcomes of elections but also predicting the impact to the broader market. Arguably the greater concern is the Coronavirus and the “what ifs” associated with a potential second wave. Investors would be wise to remember we know more about the virus than we did earlier in the year; hospitals and doctors are better equipped and prepared to handle any influx of patients, and advancements have been made in therapeutics to lower the risk of death in the majority of cases. And most importantly, by many accounts we are on the cusp of a vaccine to protect against contracting the virus – a big medical achievement with potentially massive positive implications for the economy and financial markets. Nothing is guaranteed, but just as there are reasons to be pessimistic so too are there reasons to be hopeful we’ll see blue skies soon. Your long-term allocations should have been made with risk assumptions and expectations in mind. Our recommendation for clients is to stay appropriately allocated to weather rough patches while taking advantage of stronger than expected outcomes.
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*Sources for Performance Data:
(1) Standard & Poor’s; (2) Wall Street Journal; (3) Combination of Standard & Poor’s and Bloomberg Barclay Index; (4) Lipper Analytics; (5) Wall Street Journal ; (6) Morningstar; (7) Bloomberg/Barclays Index