Market Commentary for 3Q 2020
Asset Class Recap
Stock markets performed strongly in the third quarter of 2020, continuing the second quarter’s rebound from the COVID pullback in February and March. US Large Growth Stocks have benefited from increased tech spending and continue to outperform other asset classes, returning 10.3% in Q3 and 24.3% year-to-date. The four largest stocks in that group have had terrific returns, including Apple (with a 27.2% return in Q3 and a 58.6% return YTD), Microsoft (3.6% return in Q3 and 34.3% YTD), Amazon (14.1% return in Q3 and 70.4% YTD), and Facebook (15.3% return in Q3 and 27.6% YTD). Value, Small Cap and Non-US Stock asset classes had a good quarter, but have not yet fully recovered to their price levels from the start of the year.
Corporations fall into roughly three groups, affected by COVID in distinctly different ways. The first group has benefitted from an abrupt change in consumer spending habits. Increased online buying has given a boost to online retailers and some manufacturers who have started to sell directly to consumers online (Nike stock is up 28.3% in Q3 after surprisingly strong online sales that bypass middle-man shoe stores). As people get sick with COVID or spend on preventative measures (sanitizer, facemasks, etc…), many healthcare providers are benefiting financially. Home improvement spending is up, as people are forced to spend more time at home.
The second group is muddling along and is profitable, but less so than they would be normally. They may be experiencing some decreased spending, as unemployment has jumped and people are not going out as much. Examples include auto dealerships, financial firms, and manufacturing firms.
The third group is in financial trouble. They have seen revenues drop below expense levels, they have been losing money over the last nine months and are at risk of going bankrupt (or already have, like J. Crew, Lord & Taylor, Pier 1, Sizzler, and Chuck E. Cheese ) if we do not get a vaccine soon. These include movie theaters, cruise lines, airlines, and retailers that depend on foot traffic for sales (the “brick and mortar” model). A stock price pattern has emerged, where each day that we get good COVID related news (vaccine progress or lower infection rates), this group of stocks has a good day. Each day a vaccine seems further away, these stocks drop in price.
Fixed income asset classes had positive returns for the quarter as the yields changed little throughout the quarter. The yield on 10-year treasury notes was 0.68% on 6/30/20 and was the same on 9/30/20. High Yield bonds had a good quarter and now have a positive total return year-to-date. Some of the concerns about defaults on risky bonds have subsided and credit spreads (a measure of the riskiness of these securities) have tightened a bit.
As usual, there are plenty of things to worry about that could affect markets negatively, including -
· Political uncertainty is high, as elections are one month away and we have an open seat on the Supreme Court. A presidential win for the left (which is currently given a 66% probability on betting site www.predictit.org) could mean that tax rates go back up to more historically normal levels, which would reduce corporate earnings.
· Some states have recently reported an uptick in COVID cases and expect further increases with winter’s return.
· We have not had any resolution to trade war concerns with China.
· There have been new discussions about anti-trust hearings for some of the largest tech companies in the US. Breaking these firms up or fining them for anti-competitive behavior would hurt earnings.
· Valuations for nearly all US stocks are above historical highs, which may be justified given current interest rates, but which could quickly reverse if rates tick up.
· Government spending and aid during 2020 has far surpassed historical highs, funded by huge debt issuance, and slowing down spending may cool the economy.
These concerns are balanced by potential for further market growth, driven by -
· If a COVID vaccine is brought to market sooner than expected, the market could pop on expectations that the economy will return to normal soon.
· If interest rates in the US drop further toward the lower levels we see in many other developed nations, price-to-equity multiples should increase for stocks and prices should go up.
· A presidential win by Biden may be viewed by some as a move toward four years with more “level-headed” political, diplomatic, and foreign policies that could bring additional confidence in capital expenditures by corporations.
From a historical context, market prices look expensive for stocks and bonds in the US and abroad. However, considering all of the factors listed above, staying fully invested at long term asset allocation target levels seems prudent.