Market Update


Stocks continued on the recovery path in the third quarter.  The S & P 500 was up 8.9% led by large cap growth stocks. All economic sectors were in positive territory except Energy. The second quarter’s rebound in crude oil prices stalled last quarter impacting energy stocks which declined over 20%. Small cap, international, and value stocks also gained ground, but at about half the pace as large cap stocks. While the S & P 500 is now up for the year the other equity classes are all still negative.

Interest rates haven’t changed much during the quarter, remaining at historical lows.  What has changed is the Fed’s policy shift towards inflation. Last month the Federal Reserve indicated it will keep the Federal Funds rate at or near zero even if inflation exceeds its previous ceiling of 2%. The labor market will need to return to maximum employment, and inflation will need to maintain an increase above 2% for an extended period before rates are increased.  Ultra-low interest rates should continue to help the economic recovery.

The global pandemic has inflicted a considerable amount of human and economic suffering this year.  Last spring, the global economy contracted by the largest amount on record.  This fall many questions remain around the ability to return to work, school, and reopen the economy.  Massive government stimulus programs around the world have helped bring the economy back, and third quarter growth is expected to surge. In the U.S., GDP is expected to increase over 30% on an annual pace.  But for the full year, 2020 GDP is still expected to be down around 4.5%.

Spending on consumer services remains bleak. In a partially opened economy, restaurants and small shops are experiencing a meager level of revenue which in many cases is not sustainable. Businesses involved with travel, hospitality, and personal services will also take on a greater share of bankruptcies and permanent closings.  It may be several years before this comes back, in some cases we may have seen a permanent change.  Other areas of the economy are doing much better.  The forced migration to online sales and home shopping have offset sales declines from mall and brick and mortar stores. The ease and efficiency that consumers have experienced with online shopping will keep a portion of these sales from going back to traditional in store shopping.  During the summer, consumer spending actually exceeded its pre-pandemic level back in February. Big box retailers, home improvement, and grocery stores are all thriving.

The unemployment rate is down to 7.9% from its peak at 14.8% in May. About half the jobs lost have been recovered. Unlike past stimulus programs that depended on bank lending, the CARES act put funds directly into the hands of the consumer.  The Covid-19 crisis is not over, but the recovery is progressing faster than expected. Consumer savings hit an all-time high in August.  Both concerns about the economic outlook and the inability to spend on travel and dining have contributed to the high savings rate. The very healthy savings rate should be a source for strong consumer spending over the next year.

A recent increase in Covid-19 cases may put the economic recovery on pause.  An additional round of stimulus will be needed to provide support until a vaccine is out next year.  Currently, there are nine companies globally that are in phase 3 trials for a vaccine, with numerous other vaccines in earlier trials, as well as hundreds of drugs and medical applications for Covid-19.  There is reason to be optimistic about this pandemic being over by this time next year.  To bridge the gap, the Fed is calling for more fiscal stimulus, and Congress agrees.  There is a fair amount of debate over the size needed.  All assume at least another $1 trillion is needed.

The housing market remains healthy.  Driven by record low mortgage rates, demand is strong for new and existing home purchases.  Mortgage application rates are at the highest level in over ten years. In our expanded work from home environment, city dwellers and apartment renters are looking for more space in the suburbs.  The latest home sales report showed a 12% yearly increase, with properties selling at the fastest pace since 2016.

Global trade is shifting away from China.  U.S. bipartisan concern over a range of issues including Covid-19, intellectual property theft, supply chains, and maritime border disputes are shared with other countries. Japan recently offered subsidies to firms shifting their manufacturing base away from China.  India is offering subsidies to entice technology businesses, and Australia has been a very vocal critic.  We see a continued shift in the supply chain away from China toward Southeast Asia, Mexico, and Eastern Europe.  U.S. technology companies dependent on Chinese trade may bear the brunt of any retaliation,

Market breadth remains narrow, led by strong performances among a handful of tech giants.  Although the S&P 500 is up for the year, the average stock is still more than 10% below its high. Almost one-third of S&P 500 stocks are 25% below their 52-week high.  We believe the divergence between the more expensive tech stocks and the laggards will narrow as the economy reopens over the next year. This includes many consumer cyclical stocks, financials, industrials, and services.