Q3 2020 Market Commentary + Outlook

Each quarter, Aldrich Wealth Partner Nicole Rice and Chief Investment Officer Darin Richards provide market commentary and make projections for the upcoming quarter. This conversation is accompanied by a deeper dive into market performance and outlook, as well as featured articles on popular topics such as retirement planning and changes in interest rates.

The S&P 500 Index delivered an 8.9% return for the third quarter. Abroad, developed markets returned 4.8% while emerging markets rose 9.6%. The United States gross domestic product (GDP) declined by an annual rate of 31.4% in the second quarter but is expected to expand by an annual rate of 35.3% in the third quarter. For now, former Vice President Joe Biden is viewed as the favorite to win the highly anticipated November 3rd presidential election. In the run-up to the election, investors should expect heightened volatility. After the outcome of the election is determined, upward market movement will be largely dependent on COVID-19 vaccine candidates’ success and additional fiscal relief.

The S&P 500 Index returned 8.9% over the third quarter of 2020, setting all-time market highs and bringing year-to-date returns for the large-cap index into positive territory. The strong quarterly showing follows an even stronger second quarter in which the index returned 20.5%. Not since 2009 has the S&P 500 Index experienced a two-quarter period with higher returns. Over the preceding six months, the market rebound comes on the heels of a precipitous first-quarter drop that saw the S&P 500 Index fall nearly 35% and brought an end to the longest-running bull market in U.S. history. On the year, the large-cap index is up roughly 5.6%.

Ten of the 11 underlying sectors of the S&P 500 increased over the quarter. Among the leading sectors were consumer discretionary and information technology. The two sectors have led the index higher on the year, having respectively returned 23.4% and 28.7% through the third quarter. Energy was the lone declining sector, declining 19.7%. Energy remains the poorest-performing sector within the index, having fallen 48.1% year-to-date.

Large-cap stocks again performed better than more domestically focused small-cap stocks, and growth stocks continued to outperform value stocks. The performance gap between growth and value stocks for the year has been outsized. The Russell 1000 Growth Index has increased 24.3% on the year, while the Russell 1000 Value Index has decreased 11.6%.

International stocks also delivered positive returns for the third quarter. The MSCI EAFE Index, measuring the performance of developed-country stocks, rose 4.8%. Developed-market returns were, in part, bolstered by positive news out of the European Union, where members agreed to a €1.8 trillion relief package. The landmark package is to be funded by the EU’s first-ever issuance of common debt, a move that signals a new degree of fiscal integration for the 19-member Eurozone. The MSCI Emerging Markets Index increased by 9.6%, lifted higher by Taiwan, India, and South Korea. Year-to-date, both the MSCI EAFE and MSCI Emerging Markets indices are in negative territory.

The Bloomberg Barclays U.S. Aggregate Bond Index returned 0.6% for the quarter, while the broader Bloomberg Barclays U.S. Universal Index returned 1.0%. High-yield bonds continued their rebound from the first-quarter selloff, returning 4.7% over the quarter. Another bright spot in the fixed-income market has been U.S. Treasury inflation-protected securities, or TIPS, which returned 3.0% over the last quarter. At their August meeting, the Federal Reserve announced they would set an average inflation target of 2.0% and allow inflation to move above 2.0% for an extended period to account for low current inflation. This announcement suggests that they will keep rates low for longer than initially expected. The current target federal funds rate of 0-0.25% was set in March of this year.

The heavily service-oriented U.S. economy has been hit hard by the coronavirus. U.S. GDP declined by an unprecedented annual rate of 31.4% over the second quarter. This record contraction of GDP is more than three times larger than the previous record set in the first quarter of 1958 when the economy contracted by an annual rate of 10.0%. The 31.4% decline in GDP for the second quarter follows a 5.0% decline in GDP for the first quarter, meaning the U.S. economy is now officially in the midst of a recession (defined as two consecutive quarters of negative economic growth). After peaking at an all-time high of 14.7% in April, the unemployment rate has gradually trended downward. For the month of September, the unemployment rate was 7.9%. Approximately half of the more than 22 million jobs that were lost have been restored.

Fortunately, economists are forecasting this record contraction will be followed by a record expansion. In its latest estimate, the Federal Reserve Bank of Atlanta predicts U.S. GDP will expand at an annual rate of 36.2% in the third quarter of 2020. For the year, the Federal Reserve estimates GDP will decline by 3.7%. For 2021, the Fed estimates GDP will increase by 4.0%.

Economic growth stalled in September after another spike in coronavirus cases and a stalemate on additional stimulus talks. Consumer spending slowed as most of the fiscal stimulus measures expired at the end of July, and consumers became more cautious.

For the remainder of the year, we expect stocks to be fairly range-bound. Still, volatility will likely be higher, and a long, drawn-out presidential election could lead to a pullback in stocks as investors wait for clarity. Following the election, and once the president is determined, investors will again focus on the virus. It will likely take several quarters to inoculate people after a vaccine protocol is established. Rather than wait, stock prices will likely move higher on the news rather than the actual event. This approach from investors could unleash a strong recovery in stocks as investor sentiment improves.

Additionally, money market balances are at all-time highs, and given the low interest rate environment, it is likely the funds will leave once risk dissipates. A majority of the money will likely flow into stocks, and this could provide a nice boost. Interest rates are at all-time lows and look poised to hold steady for several more years. The low interest rates have helped boost stock valuations, and although valuation multiples are elevated, they are reasonable given the current low rate environment. At this stage, stocks don’t appear to be notably over or undervalued relative to low interest rates. A setback in virus cases or lack of progress on the vaccine front could put downward pressure, while increased stimulus or positive developments with vaccines could boost stock prices. Given the alternatives’ binary nature, a more balanced approach rather than leaning toward one outcome is prudent.

Fixed income markets offer very low yields and little support in the event of a decline in equity markets. September was a good example of stocks moving lower and bond prices declining as well. This environment will likely continue for several years. With interest rates low across all maturities and yields on non-investment grade bonds below their long-term averages, reaching for yield by lengthening maturity or dropping in credit quality isn’t attractive. Defaults will likely increase as well, given the end of stimulus and continued drag from the virus. Increasing relative equity exposure is a viable option for improving portfolio return in this low rate environment; however, with the elections looming, this decision is better addressed after the presidential race is over.