Third Quarter Market Review
“The average long-term experience in investing is never surprising, but the short-term experience is always surprising.” – Charley D. Ellis, CFA, Founder of Greenwich Associates
To say that financial markets have been on a roller coaster ride in 2020 is an understatement. As distinguished consultant and researcher Charley Ellis states above, we would not have guessed that equity and fixed income markets would have rebounded so quickly given the volatility surrounding the race to stamp out the coronavirus and the race for the White House in the same year.
One year ago (in this Third Quarter Market Review), we noted how the economy had been supported by a resilient labor market with unemployment rates at 50-year lows (hovering around 3.5%) with consumer and business confidence running high. Less than six months later, we came off the boil due to a virus that shut down the world, upended global growth, and sent the unemployment rate in the U.S. spiking and settling to a current rate of around 8%. Despite this backdrop, the Nasdaq index, which includes many of tech’s heavy hitters, is up 25% year-to-date through the end of the third quarter! It’s hard to imagine that from the March 23rd lows, the S&P 500 would be up over 50% and closing the quarter up 5.5% year-to-date. Looking under the hood, as of mid-September, the top five stocks in the S&P 500 made up over 20% of the index and were up 34% year-to-date, while the remaining 495 stocks were down -4%. The main drivers of this quarterly rally remained the same, the government’s unprecedented fiscal and monetary response, coupled with expectations of a near-term breakthrough in a vaccine for the virus. Fixed income markets continued to heal, as liquidity from the Federal Reserve’s quick response has been a significant reason major fixed income indexes are displaying returns looking more like stocks than bonds.
Growth Oriented (Equity) Benchmarks
Income Oriented (Bond) & Cash Benchmarks
So where does that leave us for the remainder of the calendar year? Several pieces of research crossed our desks this quarter suggesting increased (or at least continuing) volatility into 2021. Research from DataTrek indicates the S&P 500 has moved up or down 1% almost half the trading days year-to-date. The 1% figure is significant as their research suggests that level is how much investors “feel” changes in asset prices. In normal markets, there might be one 1% move a week, (or about 52 1% moves a year). Here’s how we’ve been trending thus far, compliments of research by Jessica Rabe at DataTrek:
- Q1 2020: # of +/-1% moves in the market: 30 versus the Q1 average of 13 since 1958 (first full year of data)
- Q2 2020: # of +/-1% moves in the market: 38 versus the Q2 average of 13
- Q3 2020: # of +/-1% moves in the market: 21 versus the Q3 average of 13
- 2020 YTD: # of +/-1% moves in the market: 89 surpassing the whole-year average of 53 over the last 6 decades. The annual record is 134 in 2008
If the fourth quarter of 2020 averages anything like the first three quarters, we’ll finish just under 2008 levels of volatility. We think this is highly likely given a few issues. From a market perspective, it’s been argued that current valuations relative to future earnings are high. For many of the companies that have led us out of the recession, there is the potential for heightened anti-trust regulation that could upset markets given these firms’ relatively hefty weights in market indexes. Many market strategists are cutting their earnings estimates for the fourth quarter due to Congress remaining far apart on passing a fifth relief/stimulus package. Although markets are “pricing in” a Biden-Harris presidency, we’ve seen how wrong prognosticators can be. Of course, a lot of this uncertainty could abate if we get a vaccine sooner rather than later, as markets anticipate a return to normal. Volatility doesn’t always portend negativity or that markets will go down, but if they do we will be on the lookout for opportunities and position clients to participate in any upside volatility, as risk comfort allow.
JP Morgan recently encapsulated what they believe lies ahead for the fourth quarter, stating: “As we enter the fourth quarter, investors may find themselves optimistic about the prospects for economic growth after what will likely be an impressive rebound in GDP in the third [quarter]. Indeed, following a historic 31.4% q/q [quarter-to-quarter] contraction in the second quarter, data suggests the third quarter will likely see an equally impressive 35% q/q gain. While visually this may appear to be a “V”-shaped recovery, investors should recognize that the continuing effects of the pandemic and indecision on fiscal stimulus from Washington will likely cause growth to moderate into 2021. As evidenced last week, the unemployment rate still remains elevated, personal incomes fell 2.7% in August as a result of the lapse in Federal unemployment insurance benefits, and manufacturing activity has moderated after rebounding strongly. Altogether, growth should moderate to roughly 2-3% through the first half of 2021. As shown in this week’s chart, if our third quarter 2020 estimate is realized, it would still leave the level of third quarter real GDP about 4.2% below the pre-COVID-19 trend and about 3.1% below the level of GDP in fourth quarter 2019. To put in context, the financial crisis resulted in a 4.0% decline in GDP, highlighting the magnitude of the last recession. It still looks like 2021 will be a year of recovery for the economy, albeit a modest one until the distribution of a vaccine. This suggests the need to hedge against equity volatility in the short run while maintaining equity exposure to take advantage of an economic surge once COVID-19 has been tamed.” (emphasis by JP Morgan)
And we’ll do just that, creating globally diversified portfolios to provide a smoother ride over time; as Charley Ellis said, the long-term is rarely a surprise. As always, we thank our clients and friends for your continued trust and support of Madison Wealth Management and wish everyone a safe and healthy fall as we move into the holiday season.