2020 continues to be one of the most unpredictable years in memory. In the third quarter, markets rose to new all-time highs despite a resurgence in coronavirus cases. Stocks rallied thanks to a combination of extremely accommodative Fed policy, hopes for a COVID-19 vaccine, and a stronger-than-expected economic rebound. Then, in September, markets declined moderately from those highs amid increasing uncertainty about the future.
The third quarter began with a resurgence of coronavirus cases in the United States, as new daily cases of COVID-19 smashed through levels seen in March and April, eventually topping out at a record 78,871 new cases on July 24th. But unlike March and April, stocks did not decline following the spike in new cases, as state governments enacted more surgical economic shutdowns instead of the wholesale lockdowns that occurred in the first half of the year. That change in strategy, combined with the fact that hospitalization rates and mortality rates of COVID-19 remained far below March and April levels, helped the stock market look past the increase in cases, and the S&P 500 rose 5.51% in July.
The rally continued in August, aided by the peak and subsequent decline of coronavirus cases in some of the largest U.S. states (California, Florida, and Texas). Additionally, despite the expiration of the CARES Act stimulus, U.S. economic data continued to improve throughout August, powering stocks higher. Finally, in late August the Federal Reserve formally announced the adoption of an “average inflation target,” which effectively signaled the Fed would tolerate higher inflation in the economy more so than in recent history. That policy shift is a potentially longer-term bullish event for stocks as they are positively correlated to higher inflation. Led by gains in the tech sector, the S&P 500 hit a new all-time high in mid-August and the rally continued through month-end. The S&P 500 rose 7.01% in August and finished the month in solidly positive territory on a year-to-date basis.
The final month of the third quarter, however, provided a reminder that the macro-economic outlook remains uncertain and markets can still quickly become volatile. The tech rally in August was so relentless that it elicited comparisons by the financial media to the tech bubble of the 2000s. While that was somewhat hyperbolic, the pace of the gains in the tech sector simply wasn’t sustainable. In the first few days of September, the tech rally became exhausted, the Nasdaq peaked, and stocks began a correction process that would last for most of the month. From a catalyst standpoint, the initial declines were a function of buyer exhaustion, but there were also some incrementally negative events in September that weighed on stocks. First, it became evident that there would be no new economic stimulus bill in September, as Democrats and Republicans remained far apart in negotiations. Second, economic data began to imply a “plateau” in the economic recovery. Finally, late in the month, coronavirus cases surged in Europe and began to move higher again in certain U.S. states, prompting some concern about a return to various levels of economic lockdown in Europe and the U.S. The S&P 500 declined modestly in September but remained solidly positive for the third quarter.
Looking forward, as we begin the final quarter of this historic year, the market correction of September helps to reset expectations about the numerous unknowns still facing investors in both the short and long-term. We start the fourth quarter of 2020 at more reasonable market valuations, historically speaking.
A Deeper Look at Q3 Market Performance: New All-Time Highs
The major U.S. stock indices all extended the rebound that began in the second quarter of 2020, and just like the previous two quarters, the tech-heavy Nasdaq outperformed the other major indices. Those gains were once-again driven by the performance of some of the largest, most-well-known tech companies in the world, as they are viewed as the longer-term beneficiaries of changing personal and professional behavior in response to the pandemic. Stocks such as Apple (AAPL), Amazon (AMZN), Google (GOOGL), and Netflix (NFLX) helped send the Nasdaq to new all-time highs in July, August, and early September.
By market capitalization, large-cap stocks outperformed small-cap stocks, a reversal from the second quarter. Large caps outperformed primarily because doubts remain about how quickly the U.S. economy will return to pre-COVID 19 levels, especially with the expiration of economic stimulus in late July. Since small caps are historically more sensitive to changes in broad economic growth, that uncertainty weighed on small-cap indices, although they still finished with a positive return for the quarter. From an investment style standpoint, growth outperformed value, yet again, because of strength in large-cap tech.
On a sector level, 10 of the 11 S&P 500 sectors finished with a positive return for the third quarter. As previously mentioned, tech outperformed, but so did consumer discretionary and materials sectors, as investors rotated into some of the hardest hit sectors in the market on the hope that coronavirus cases would continue to recede and people would venture back out into the economy, visiting malls and restaurants, and traveling sooner than previously expected.
Defensive sectors, those that are historically less sensitive to expected changes in the economy such as utilities, consumer staples, and healthcare, lagged the S&P 500 in the third quarter, although they all posted solidly positive quarterly returns. The only S&P 500 sector to finish with a negative return in the quarter was energy as investors continued to worry about future global demand in the context of still-elevated oil supplies.
International markets rallied in the third quarter as European and Asian economies continued to re-open. However, many foreign developed markets closed well off the highs of the quarter as coronavirus cases spiked in parts of Europe, particularly in Great Britain. Emerging markets outperformed foreign developed markets thanks to a continued decline in the U.S. dollar paired with strength in Asian markets, as the coronavirus outbreak remains broadly contained in that region of the world.
Commodities moved higher in the third quarter thanks to a declining U.S. dollar, combined with cautious optimism for an eventual global economic rebound. Oil prices were volatile in the third quarter but still finished with a positive return as OPEC maintained discipline on supply cuts, which helped offset concerns about global oil demand expectations. Gold, meanwhile, added to the gains of the second quarter thanks to the weakness in the U.S. dollar, still-recovering inflation expectations, and steady bond yields amid the historic global central bank stimulus.
Switching to fixed income markets, the total return for most bond classes was again positive in the third quarter, as bonds now have realized a positive return for each quarter so far this year. The leading benchmark for bonds, the Bloomberg Barclays US Aggregate Bond Index, saw slightly positive returns in the third quarter, marking the eighth consecutive quarterly gain.
Longer-duration bonds again outperformed those with shorter durations in the third quarter as global central banks (including the Federal Reserve) reiterated that rates would stay low for years to come. That anchored shorter-duration bonds, and in turn increased the appeal of higher-yielding, longer-maturity bonds.
Corporate bonds saw solidly positive returns in the third quarter thanks to the better-than-expected economic recovery. High-yield bonds outperformed investment-grade bonds during the quarter, reflecting surprisingly strong corporate commentary during the most-recent earnings season combined with optimism that a continued decline in coronavirus cases would help business continue to recover.
Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.