Third Quarter 2020: Market Review & Outlook
Following a wild first half of 2020, the third quarter brought continued recovery with most major indexes posting gains. The S&P 500 rose 8.9% for the quarter, marking its best third-quarter performance in a decade and bringing its year-to-date performance into positive territory with a 5.6% return. In mid-August, the S&P 500 reached its first all-time high since February. The market continued to climb until early September when valuation concerns drove a shift in performance between growth and value and market volatility increased.
Despite the September pullback, growth stocks continued to lead in Q3. The Russell 3000 Growth index now leads the Russell 3000 Value by more than 35% year to date — its largest recorded margin of outperformance since 1979, according to Bank of America. Large cap stocks were back in favor during the quarter with the Russell 1000 returning more than 9.5% in the quarter versus 4.9% for the Russell 2000. Small caps continue to trail large by more than 15% year to date.
Despite its year-to-date lead, Information Technology finished Q3 fourth out of the S&P 500’s 11 sectors amid a selloff in Big Tech mega cap names. Consumer Discretionary, Materials, and Industrials led for the quarter. Energy was the only sector that declined in Q3, due to renewed growth concerns and September’s sharp decline in WTI Crude oil prices.
The Federal Reserve’s shift to average inflation targeting made news during the quarter, potentially indicating that rates are likely to remain lower for even longer. U.S. Treasuries, as measured by the Bloomberg Barclays U.S. Government Bond Index, gained just 0.2%, lagging investment-grade bonds (as measured by the Bloomberg Barclays U.S. Aggregate Bond Index), which returned 0.6% in the third quarter.
Macroeconomic data remained mixed in the quarter. Although consumer spending increased 1% in August, lower unemployment assistance resulted in personal income declining 2.7% relative to July. Additionally, while there has been significant improvement in employment data, both initial and continuing jobless claims remain stubbornly high. Without further fiscal stimulus or a significant improvement in the labor situation, consumer confidence could face serious headwinds, which would drag on the economic recovery.
Industrial production rose for the fourth consecutive month in August, but at a much lower rate than earlier in the summer, possibly indicating a slowing recovery in manufacturing. Record low mortgages, pent-up demand and increased work from home capabilities led to an improved Q3 for housing with home prices up 4.8% in July, compared to 2019.
Equity market gains continued through another quarter, but we believe caution is warranted. The market has been heavily skewed toward a narrow band of high-growth stocks and if the market continues higher, we would expect a certain amount of profit taking following what has been a multiple-expansion driven rally, specifically within the tech sector.
As we enter the fourth quarter of this unusual year, there is still much uncertainty and rising COVID-19 case counts, combined with a very different kind of election cycle, are among the factors likely to increase volatility.
These two factors, along with the combination of fading benefits from fiscal stimulus, potential for absence of additional stimulus, encouraging progress on the vaccine front, growing speculation about rotation into cyclical and value focused sectors, and continued tension between the U.S. and China are the main items we are watching for the remainder of 2020.