Equity Market Update
Large U.S. stocks performed well in the 3rd quarter with the S&P 500 returning 8.93%. The summer months were particularly favorable for markets while September was relatively challenging. The S&P 500 returned -3.80% in September as expectations for another round of fiscal stimulus faded and the labor market slightly deteriorated. Mid-caps (S&P MidCap 400) and small caps (Russell 2000) followed the same trend as the S&P 500, performing well in July and August while struggling in September. International stocks, which continue to lag large U.S. stocks for the year, provided positive returns to investors during the third quarter. Emerging market stocks were among the best performing equity asset class, returning 8.94% in July and 9.56% for the quarter. International stocks benefited from the economic recovery in China and the depreciation of the U.S. dollar. The positive returns for global stocks in the third quarter can be attributed to reopening optimism and an improvement in business activity.
Source: Morningstar. International Developed measured by the MSCI EAFE NR USD. Emerging Markets measured by the MSCI EM NR USD.
Equity Market Themes
Two themes have dominated the market in 2020.
First, growth-related U.S. stocks have significantly outperformed many other asset classes by a wide margin. The Russell 1000 Growth Index has returned 24.33% in 2020 and 37.53% over the past 12 months. The Russell 1000 Value Index has returned -11.58% in 2020 and -5.03% over the past 12 months. The difference in return between growth and value can be attributed to the fact that many growth companies were less impacted by Covid-19 than originally anticipated, and some companies even benefitted as many citizens were forced to shelter in place and work from home. This theme accelerated profits and growth for many technology firms and allowed companies such as Amazon to maintain consistent profits.
In contrast, value stocks have been significantly impacted by Covid-19 as uncertainty related to employment and the health of the economy forced consumers to delay significant purchases. In addition, the Russell 1000 Value Index has higher exposure to financial and energy stocks, which are the two worst performing sectors this year.
The second major theme relates to the concentration of performance within the stock market as the top positions in many major indices have been the main drivers of positive returns. For example, the top 5 holdings within the S&P 500 include Apple (6.5%), Microsoft (5.6%), Amazon (4.8%), Alphabet (3%) and Facebook (2.2%). All 5 positions have significantly outperformed the S&P 500 on a year-to-date basis and have buoyed the returns of the index. The chart below compares the returns of the top 5 holdings in the S&P 500 to the remaining 495 companies. As of the end of August, the top five positions returned 59.48% while the remaining positions returned 0.74%. The outperformance of the top positions helped the S&P 500 return 9.75% on a year-to-date basis as of the end of August. This is truly an anomaly as the current composition of the S&P 500 is the most concentrated it has been since 1964.
Bonds performed relatively well in the third quarter as the Bloomberg Barclay’s Bond Index returned .62%. Certain sectors of the bond market - whose risk and return are based on the creditworthiness of the issuer - outperformed the U.S. Bond Aggregate. Both U.S. Corporate bonds and U.S. High Yield bonds returned 1.54% and 4.71%, respectively, during the third quarter. High yield bonds typically have a positive correlation with the stock market, so a return of -1.04% in September is not surprising.
Tax-free bonds, measured by the Bloomberg Barclays Municipal Index, provided positive returns despite the economic hardships facing many municipalities around the country. The index returned 1.23% in the third quarter and outperformed a majority of the other bond-related asset classes in September (+.02%). The prospect of higher taxes in the future makes tax-free bonds more attractive to individuals in higher tax brackets – a theme that relates to the election and the proposal for higher taxes on wealthy individuals.
Drivers of future returns will be the timing and implementation of a vaccine, potential therapeutics, and the fiscal support provided by the U.S. government. The U.S. Federal Election is less than one month away, and the prospect of a contested election may create additional uncertainty for markets. The Federal Reserve continues to provide monetary support by keeping interest rates at their current levels and by providing financial support to corporations and municipalities through various programs. The U.S. economy tends to do well when consumers have access to credit, so low interest rates should continue to increase consumer demand for many products and services. While it is clear the Fed can partially support the economy via low interest rates, the uncertainty related to the timing of the next round of fiscal stimulus from the U.S. government could cause short-term market volatility.
Investors should prepare themselves for heightened market volatility that will likely remain elevated until we have greater clarity on the election and the U.S. economic growth outlook. Corporations will soon begin to release third quarter earnings over the next few weeks, which should give investors insight into how companies have been performing and what to expect in terms of profits over the next few months.
We continue to value the trust you place in our firm and are happy to answer any questions you may have.
Matthew A. Somberg, AIF® Nicholas Hogrefe, CFA®, CFP®
Partner and Founder Senior Research Analyst
Accredited Investment Fiduciary® Chartered Financial Analyst®
CERTIFIED FINANCIAL PLANNERTM
Disclaimer: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimations, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the US and Canada. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment- grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. Statistics cited are from Morningstar and the US Department of Commerce.
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