Market Commentary - Q3 2020

Stocks have best two-quarter performance since 2009 (30 September 2020)

US equity markets finished their second straight quarter of big gains. The market’s run extended a historic and rapid recovery that few predicted in the depths of the March downturn, the likes of which we have never seen before.

The S&P 500 and Nasdaq Composite hit a string of records in the third quarter, The sheer velocity and strength of the rally has baffled many investors as the overall economy still struggles to rebound from COVID-19 shutdowns. Comparing US equity market returns to overseas markets, the US has significantly outperformed:

Source: WSJ

What's driving the market

Economic Recovery 

The economy up to now has rebounded more quickly than many economists thought. But with federal aid fading and job growth slowing, consumer spending—the key driver of economic activity in the US could weaken. Economists believe the recovery is entering into a modest and more grinding phase.


The US economy and labor market have significantly improved from the COVID-19 bottom, though it remains far from where it was to start the year.  The unemployment rate has dropped rapidly from nearly 15% in March to 7.8% in September, a pace much quicker than many economists predicted. However, there are signs that the labor market recovery is losing steam as jobless claims have come in over 800,000 for the fifth straight week.

The level of new claims shows layoffs more prevalent in some industries like hospitality, travel, commercial real estate, and retail. Airlines laid off more than 50,000 employees on October 1st as a stimulus deal was not reached and Disney laid off 28,000 workers as individuals are not ready to travel just yet. It is becoming increasingly evident that more layoffs that were originally thought to be temporary are becoming permanent.

Consumers experience a summer high

Consumers increased spending over the summer, as they made up for purchases they put off during the spring and bought goods such as bicycles, cars, groceries and home improvements. But the August boost to spending of 1% was far smaller than earlier in the summer when spending grew 9% in May, 7% in June and 2% in July. Spending on services such as dining out, hotels, and air travel remains far below pre-virus peaks.

Housing boom

The combination of low interest rates and individuals and families flee big cities amidst the pandemic for the suburbs, the housing market has exploded. Among the big winners in the third quarter have been shares of home builders, which have benefited from an epic housing boom as the pandemic has created a historic shortage of homes for sale. Americans have been rushing to land more living space, anticipating they will continue working from home during the pandemic. 

The combined effect has created an extreme drought of previously owned homes for sale. At the end of July, there were 1.3 million single-family existing homes for sale, the lowest count for any July in data going back to 1982, according to the National Association of Realtors. In the week ended Sept. 12, total for-sale inventory was down 29.4% from a year earlier at the lowest level since at least late 2017.

The shortage has pushed home prices higher, stretching the budgets of many middle-class and first-time home buyers. Home sales rose in August for the third consecutive month, fueled by robust demand for luxury homes and a pickup in Northeast sales that kept the housing market hot.

Sales of previously owned homes rose 2.4% from a month earlier to a seasonally adjusted annual rate of six million. The median sales price of an existing home in August was $310,600, 11.4% higher than in the same month last year. That built on a 24.7% surge in July home sales, which was the strongest monthly gain ever recorded, dating back to 1968.

Don’t fight the Fed

The Federal Reserve approved a shift in how it sets interest rates in the third quarter, signaling it would leave them low for years. In September, the Fed stated that they expect to keep rates near zero at least through next year and would stay there through 2023.

The Fed’s rate-setting committee also revised its post meeting statement to specify it would maintain rates near zero until it sees evidence of a tight labor market and inflation reaches 2% “and is on track to moderately exceed 2% for some time.”

Fiscal stimulus

Congress passed $3 trillion in fiscal stimulus in the spring which has propelled the economic recovery during a time when it was in dire need. Federal Reserve Chairman Jerome Powell warned of potentially tragic economic consequences that could result if Congress and the White House don’t provide additional support to households and businesses disrupted by the coronavirus pandemic.

“The expansion is still far from complete,” Mr. Powell said. “At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship.”

By contrast, the risks of providing too generous relief are smaller, he said. “Even if policy actions ultimately prove to be greater than needed, they will not go to waste,” he said.

However, President Trump disregarded Mr. Powell’s warnings and has stopped talks with House Speaker Nancy Pelosi over another coronavirus relief package, saying he would take up the issue after Election Day. The two sides remained at odds over how much state and local aid to include in an agreement.

Economic conclusion

While the economic recovery is slowing, it is still very much intact as more businesses are opening than closing. There is very limited risk of a double dip recession, stimulus is still coming, however it might be after the election now rather than before.

Where are we in the business cycle?

On March 27th, we wrote a piece regarding seeking opportunities in business cycles. Our analysis proved to be correct as we rotated client assets out of bonds and cash to the Nasdaq 100. The Nasdaq led global equity markets in the rebound from the March bottom. 

We have seen one of the quickest “Early” stages of the business cycle in history and a sharp V recovery. Even with the stalling of fiscal stimulus, I believe we are in the Mid cycle of the business cycle.  The mid stage is typically the longest phase of the business cycle and displays positive but more moderate growth than the early stage.

Q4 and 2021 Outlook

There has been a decade-long battle between growth stocks and value stocks with growth leading the charge of outperformance. However, we have begun to see a rotation from growth stocks to value stocks over the month of September. While it is hard to bet against the meg-cap technology companies, We believe we will see a resurgence in value stocks, although it may not outperform the earnings capacity of growth. 

Headwinds for growth stocks are as follows:

  • Regulatory pressure on Apple, Amazon, Google, and Facebook - While we do not believe the tech companies will be broken up, this will be years of court battles and headline pressure.
  • Biden/Blue sweep - If Biden and the Democrats sweep the 2020 election, corporate taxes are set to increase which will weigh more heavily on the tech industry over others. Also, capital gains taxes will increase under this scenario and investors will look to sell holdings that have the highest gains before this increase takes place.
  • Valuations are historically high - While this market is less of a fundamentals driven market than we’ve ever seen before, many of the tech names have run up quite dramatically from March and the correction we are seeing in these names is healthy.

We believe there is a place for a small allocation to value stocks in a diversified portfolio, however we still favor a slight overweight to growth stocks. We will be using value stocks as more of a hedge against a technology concentration in portfolios and to take advantage of a mid stage economic cycle as value names are still well off their pre-pandemic highs and could have a rebound strongly as COVID-19 restrictions dissipate over the coming years.

It is important to keep in mind that the disconnect between equity markets and the underlying economy is largely due to the simple fact that public markets trade large corporations, who have strong earnings and easy access to capital. We invest in Wall Street, not Main Street. While there are obviously correlation between equity markets and the broader economy, equity markets tend to lead the economic recovery by six months or more. 

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