The S&P 500 and Nasdaq index had wonderful performance during the third quarter, with returns of 8.5% and 11%, respectively. However, pre-election politics obstructing a new federal stimulus package and an escalation in COVID cases caused both indexes to decline in September. The political stalemate over aid to bailout states and cities is dampening confidence. A multi-trillion-dollar stimulus package will eventually be implemented that should focus support for small businesses and unemployed individuals. The interminable wait for a COVID vaccine is also weighing on the markets and suppressing economic activity. The year-end target for a vaccine is unlikely, although a “cocktail” of antibiotics and steroids has shown to help patients recover, so the management of the virus is becoming more tenable. With the health crisis reduced, we should expect a gradual return to a stable growth economy.
The Federal Reserve is providing support for the economy in the short and long term by providing low interest rates and liquidity, but our service-oriented economy requires interactive business and consumer activity. Monetary and fiscal policy can and will restore confidence over time. While the leaders in France, Spain and the UK are implementing lockdowns again, the U.S. is emerging from an over-politicized health challenge. COVID’s slow spread is seemingly inevitable, with most people contracting the benign asymptomatic type. During this quarter, we also experienced massive fires on the West Coast, violent protests in some cities and hurricanes in the South, which restrained third-quarter GDP growth, but offer opportunities for rebuilding.
The political theatrics of the first debate produced no clear winner. Many political experts believe it will be a very close election that may not produce a clear winner for several weeks after Nov. 3. If this occurs, the uncertainty would mean more market volatility in the fourth quarter. The House and Senate elections could also change the philosophical direction of the country and increase market uncertainty.
Given the market volatility, investors searching for opportunity will find value in some of the industrial, information technology and healthcare sectors. The key to finding value in these markets is to invest in companies in niche markets with relatively high barriers to entry. Many sectors of the economy have an overcapacity in manufacturing and/or a large labor force. These companies are challenged by higher costs and deflationary pricing which will require restructuring and workforce reductions for years to come. Airlines, hotels, large financial institutions, basic materials and energy are all examples of this. Companies that are manufacturing highly precision-engineered systems and products or developing more efficient software and discovering new pharmaceutical and biological compounds are examples of niche markets in sectors where earnings will continue to grow.
During the third quarter, the best performing groups were in the consumer discretionary, industrial, basic material and information technology sectors. Small and mid-cap companies generally underperformed, as they have all year, with returns of 4.6% and 4.4%, respectively. International equities and emerging markets also generally underperformed U.S.-based equities. We remain over-weighted in the information technology, consumer discretionary, healthcare and industrial sectors as the U.S. economy gradually recovers. Historically, the fourth quarter has been positive 80% of the time with average gains of 4.2% from 1980-2019.
Index 3rd Quarter 2020 Year-to-Date
S&P 500 Index 8.5% 5.5%
S&P Mid-Cap 400 Index 4.4% -9.8%
MSCI All World Cap Index 7.6% 0.0%