Stock markets continued their climb out of the depths of the COVID plunge this spring as the 3rd quarter saw stocks (S&P 500) rise 8.9%. After falling 34% from the high of February 19th, stocks have rebounded 51.8% from the March 23rd low to September 30th, resulting in only a 0.5% rise over the whole period (2/19 – 9/30). This puts the year to date gain for the S&P 500 at 5.6%.
Stocks continue to be supported by the Fed, fiscal support, vaccine and treatment news, strong consumer spending, and a resumption of most business activities.
Where we go from here is dependent upon those same supports. The Fed continues to support the economy from a monetary perspective by keeping rates low and buying back securities (treasuries, mortgages, and corporate bonds). Vaccine and treatment news will likely continue to improve as several companies approach approval of their products to prevent and treat for COVID-19. However, the fiscal support in the way of loans and supplemental unemployment benefits has ended and a renewal or continuation of this support is still in negotiations and far from certain. Consumer spending going forward is threatened by the expiration of the fiscal benefits as well as a potential virus surge during the winter months.
The unemployment rate for September fell to 7.9% from 8.4% the previous month, but that was largely because some 700,000 left the work force. Payrolls remain 10.7 million below their pre-pandemic peak. The concerning aspect of the unemployment report is the permanent jobs lost, which has gone up over the last few months as temporary job losses and furloughs became permanent. Spending was up 1% though as savings set aside from previous transfer payments were tapped. Right now, we have already lost 100,000 businesses and it wouldn’t surprise me if that number increases over the next 6 to 12 months. Given Covid-19 is far from beaten plus the fact that the supportive impact from the fiscal stimulus is fading, caution remains warranted.
There is an astounding bifurcation between several sectors. Technology, consumer discretionary, and communication services have been leading the market up, while energy, and financials have lagged significantly. The difference in returns in the third quarter between technology and energy is 80%! Much of the S&P 500’s gains, which is weighted by the market cap of its constituents, can be attributed to 5 stocks which have a weight of 23% of the index. Those names are Apple, Microsoft, Amazon, Alphabet (i.e. Google), and Facebook. The first four have market caps north of one trillion dollars. Those five stocks are up 43.7% year to date, while the 495 other stocks in the S&P 500 are down 3.9%. They are also the primary drivers of the outperformance in the three sectors mentioned above that are leading the market: Apple and Microsoft in technology, Amazon in consumer discretionary, Alphabet and Facebook in communication services.
The impact this is having on different styles is stark. Large cap growth vastly outperforms other types of stocks by a wide margin as seen in the graph to the right, with large cap growth up 24.3% year to date while the worst style is small cap value down -21.5%.
Investors are seeking those companies that have enormous heft in their business with their solid financials, massive market share, a solid brand, and that benefit from the current environment with COVID-19 and it’s repercussions on the economy. The valuations of many companies could be considered lofty, however there are still many stocks that are at decent or cheap valuations. The valuation gap between value and growth stocks has reached record levels due to the outperformance of growth over the last decade. In September, the markets pulled back somewhat, partly due to lofty growth stock valuations as well as uncertainty due to the rising cases of the virus and the election. The NASDAQ, of which most of the technology companies are a member, was down 3.6% in September, but is still up 5.9% year to date. Value stocks though, outperformed growth stocks in the month. Could we be seeing the long awaited shift to value stocks? Only time will tell, but over the long term, value stocks have outperformed growth stocks, and value has led coming out of the past 14 recessions.
In addition to the signs of economic recovery discussed above, the fixed income market has responded to what Fed Chair Jay Powell called a “robust updating” of Fed policy. In a speech delivered to a virtual audience in an online version of the Fed’s annual Jackson Hole symposium, the Fed chair said the central bank has formally agreed to a policy of “average inflation targeting.” Under this policy, the Fed will allow inflation to run moderately above the Fed’s 2% target range “for some time,” following periods in which it has run below that target. From a practical perspective, the Fed may hold off on hiking rates when the unemployment rate falls. Although it may seem “counter-intuitive” that the Fed would want to push up inflation, the central bank recognizes that inflation that is persistently too low also can pose serious risks to the economy.
The U.S. presidential election is less than one month away. And while some have posited that having a Democrat in the Oval Office is bad news for stocks, history suggests equity markets will do fine either way.
”In terms of US election risk, there is no large difference between Trump and Biden when it comes to the overall impact on equity markets" wrote JPMorgan’s Marko Kolanovic.
But for long-term investors in broad market indexes, both candidates present a mix of risks and opportunities that roughly net out. It’s a reassuring conclusion for investors as Biden has taken the lead in the polls. And it challenges assumptions that Republicans are good for business and Democrats are bad, as history shows stocks tend to rise regardless of what party the president belongs to.
In fact, JPMorgan analysts, as well as many of their peers on Wall Street, argue a president Biden may be “neutral-to-positive for markets.” Biden’s published program entails a clear hit to corporate profits through higher taxes, but with eventual offsets such as redistribution to lower and middle-income households through a higher minimum wage and broader healthcare coverage, plus a national boost via infrastructure spending,” JPMorgan’s John Normand wrote. “A less combative foreign policy seems guaranteed (which is bearish for volatility), though the odds of tariff rollback are tougher to handicap.” The trade war with China – and the tariffs and general uncertainty it has come with – has been flagged frequently as a top risk by investors and businesses.
I am a firm believer that the fundamentals of the market are based on corporate earnings, economic growth, and interest rates; not the political party presiding over this country. While it may be more challenging than ever this year, it is important to remember not to base your investment portfolio on who the President will be. Stay focused on the long-term and do not let your personal feelings get in the way of your predictions.