During the quarter, equity markets continued to rise off their March lows as lockdown restrictions eased and the economy continued to recover. The S&P 500 returned 8.9% for the quarter and, through the first nine months of 2020, is up 5.6%.
Markets began rallying after the government’s fiscal and monetary stimulus. While this was not an unprecedented motivator for markets, as we’ve discussed (Are The Market Lows Behind Us? – A Case in Support), with so much economic uncertainty, many are still surprised. However, although the S&P 500 is reaching new highs, the breadth of the rally has been narrow, with about 90% of the stocks down for the year (for more on the breadth of the rally: S&P 500 Reaches New Highs, but Most Stocks are not Rallying) Many industries like airlines, hotels, travel, and retailers are off, which seems reasonable given the negative effects the lockdown has caused for their businesses. But many technology stocks have done well as their businesses have been boosted by the lockdown. This schism is manifested in the huge discrepancy in returns between large cap growth stocks and large cap value stocks. So far this year, large cap growth stocks are up 23% but large cap value stocks have declined 11%. Given the change in fortunes that the lockdown has created, this dichotomy has merit.
While the rise in other stock indices was similarly impressive for the quarter, many remain underwater year to date. For the quarter, the Russell Mid Cap Index was 7.5%, the MSCI EAFE Index gained 4.2%, the EAFE Small Cap Index returned 9.7%, and the MSCI Emerging Market Index gained 9.6%. A pretty impressive quarter for stocks, but they’ve had to recover from a big drop. So far this year, the Russell Mid Cap Index is down 2.35%, the MSCI EAFE Index is off 8.92%, the EAFE Small Cap Index has lost 5.71%, and the MSCI Emerging Market Index has declined 1.16%.
Yields remained low and returns on high quality bonds generally fell below 1%. High Yield and emerging market bonds fared better, returning 4.9% and 2.3%, respectively. Despite the muted returns on government bonds, inflation protected bonds performed well, returning a little over 3% for the quarter. Some of this outperformance can be attributed to investor fears of future inflation stemming from the outsized stimulus, but most can be ascribed to the Fed’s mandate change. During the quarter the Fed moved from an inflation target of 2% to an inflation target averaging 2%. This change means that the Fed could let inflation run above 2% before reducing expansionary policies. I don’t want to sound like an alarmist because I don’t think inflation is going to be a problem anytime soon. However, in the 1980s, the Fed, under Paul Volcker, took the painful but necessary steps to bring inflation under control by raising interest rates – big time. High inflation had wreaked havoc on the economy for a considerable stretch – ever since the government believed it was an easier way to pay for the war in Vietnam. We don’t want a repeat of that.
Within alternative investments, returns for many absolute return strategies fell between the returns of stocks and bonds. Within real return strategies, infrastructure and real estate stocks continued to lag. Oil prices were relatively stable compared to the big price swings we witnessed in the first and second quarter, and commodities, as a group, had an outstanding quarter, gaining over 9%.
Although the economy is improving – the unemployment rate has fallen to 7.9% and quarterly GDP growth could reach 30% on an annualized basis – a number of uncertainties remain and give us cause for caution. The recovery is uneven and having significantly different effects on market sectors, we’re in the midst of a heated presidential election, tensions with China have increased and prospects of a COVID-19 vaccine are all weighing on investor sentiment. As a result, we expect volatility to remain high as these uncertainties persist.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Washington Trust Bank.