First Quarter Investment Commentary
3rd Quarter
Commentary 2020
Four ongoing themes dominated the third quarter: 1) the virus; 2) the pace of the economic recovery and the potential for further fiscal and monetary stimulus; 3) the behavior of the stock market—specifically the large-cap tech sector; and 4) the U.S. elections.
The number of new virus cases surged during July, to a level that was far higher than that experienced during the height of the lockdown measures through March and April. Following a steady improvement through August and early September, the case count is once again mounting. However, the number of deaths has remained very low, as have the number of hospitalizations. This suggests that the surge may be related to more testing, a less virulent strain of the virus, more younger people contracting it who do not need hospitalization and whose mortality risk is much lower, or possibly—but very unlikely—herd immunity being reached much sooner than expected. Unfortunately, we still really do not know the answer, and with the continued lack of a vaccine and/or therapeutic, the potential for another wave to erupt during the fourth quarter, as we move into the autumn/winter flu season, continues to be the biggest risk facing investors at this time.
Despite this resurgence of the virus, macroeconomic growth indicators managed to handily beat economists’ expectations during the quarter, with the Citigroup Economic Surprise Index for the United States reaching its highest-ever reading in July. Furthermore, a number of economic variables, such as retail sales and the residential housing market, have experienced full V-shaped recoveries, with activity in each of these now higher than it was at the peak of the last cycle in February. There are also reasons to believe that this housing market recovery is durable and will continue for some time to come.
Nevertheless, we are not out of the woods just yet. Scratching a little under the surface reveals that the rising tide has not lifted all boats. There has been a tangible mix shift in consumption patterns as a result of the virus. For example, consumers have been shunning clothing retailers (the result of more working from home), along with many services that necessitate human interaction (nail salons, theme parks, and gyms). Meanwhile, sales for durable goods—such as autos, furniture, home furnishings, bicycles, and building and gardening equipment—have been very strong, as individuals have been snapping up new homes or remodeling their existing homes, given the increased time they are at home and the desire to spend more time in the open outdoors.
Unfortunately, we have yet to see a full V-shaped recovery in employment. From February to April, the labor market shed 22 million workers. At the time, the vast majority of those workers (78%) were deemed on temporary leave; there has since been some transition, with a rising number of permanent layoffs. Companies are discovering that in a new normal post-COVID environment, they may not need as many workers as they had previously. The majority of these layoffs have been due to a collapse in their businesses, e.g., airlines, theme parks, and restaurants; however, some have been the result of productivity improvements (companies have been forced to upgrade systems). Through September, a little more than half of those lost jobs have now been recovered, which is encouraging; however, more work needs to be done, and the easy gains have largely been made.
Financial markets have been remarkably resilient through the crisis. The S&P 500 increased by 7.0% in August, which was its best August performance in 34 years, and leading the charge yet again were the large-cap tech stocks. Some of this performance was taken back in September; the S&P 500 fell by 3.9% in the month, when the tech rally took a pause, enabling some of the more-cyclical sectors, such as materials, utilities, and consumer staples, time to catch up and thus helping broaden the stock market recovery. Overall, markets continue to place a high premium on businesses able to grow despite the economic uncertainty this year.
High-yield fixed-income markets also continued to improve during the quarter with spreads tightening by almost 100 basis points, as investors have felt increasingly comfortable taking on risk. Yet, at a current spread of 5.4 percentage points, this is still tangibly above the long-term average of 4.7 percentage points and approximately 300 basis points above the lows reached at the peak of the last cycle. The Fed’s actions have helped encourage these investors, both through their purchases of corporate debt and by their guidance toward an extended period of low rates. This rhetoric was solidified by the shift to an average inflation targeting regime, one where the Fed will tolerate moderate—but sustained—inflation overshoots to better achieve its 2% target rate over time. The Fed will have been encouraged by the fact that this language has already helped lift market-based inflationary expectations from 1.4% at the start of the quarter to 1.8% by quarter-end.
As Election Day nears, investors have increasingly started to price in higher expected volatility. A clean sweep for the Democrats is being seen as a greater risk to economic growth than other outcomes. This is because the Democratic platform calls for higher taxes (corporate and personal) and increased regulation, which would likely reduce corporate earnings. While presidential elections may lead to near-term market fluctuations, history has shown that they do not tend to be overly meaningful for the stock market over the longer term.
We are now entering a transition point, moving further away from the easy comparisons achieved during the initial rebound phase of the expansion and into the recovery phase, when future gains will be more difficult to achieve. Meanwhile, the ongoing threat from the virus, the upcoming elections, the possible ending of fiscal stimulus, and the potential for further civil disruptions on the back of these all suggest that investors should be prepared for a period of heightened volatility. In such an environment, maintaining an active management approach to investing will be a key priority in navigating these choppy waters.
We continue to be pleased with investment results during this volatile year. Our focus on high quality growth stocks and recognition that low interest rates are with us for an extended period have served us well. We will be closely watching election results and any policy changes that follow. In the event that portfolio allocation adjustments or changes to tax or estate planning strategies make sense, we will be in close contact. In the meantime, please do not hesitate to reach out to us to discuss your personal circumstances.
Mark Fuller
mfuller@williamblair.com
+1 312 364 8558
Jackie Moss, CFA, Managing Director
jmoss@williamblair.com
+1 312 364 5213
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The opinions expressed in this report are not necessarily the same as William Blair & Company L.L.C.’s Equity Research department. This information should not be construed as a research report, as it is not sufficient enough to be used as the primary basis of investment decisions. This information has been prepared solely for informational purposes and is not intended to provide or should not be relied upon for accounting, legal, tax, or investment advice. We recommend consulting your attorney, tax advisor, investment, or other professional advisor about your particular situation. Investment advice and recommendations can be provided only after careful consideration of an investor’s objectives, guidelines, and restrictions. Any investment or strategy mentioned herein may not be suitable for every investor, including retirement strategies. The factual statements herein have been taken from sources we believe to be reliable, but accuracy, completeness, or interpretation cannot be guaranteed. Past performance is not necessarily an indication of future results. All views expressed are those of the author, and not necessarily those of William Blair & Company, L.L.C. “William Blair” is a registered trademark of William Blair & Company, L.L.C.
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It was the best of times, it was the worst of times.
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S&P500
International Developed Markets
2019 Q2:
0.6%
International Emerging Markets
2019 Q2:
2.0%
Interest Rates
(10-year Treasury)
First 6 mos. 2019:
18.5%
2019 Q2:
4.3%
2019 Q2:
3.0%
First 6 mos. 2019:
13%
First 6 mos. 2019:
11%
Ben Weyers, CFA
bweyers@williamblair.com
+1 312 364 8870
-17.12
US Real Estate
MSCI US REIT
3.33
US Muni Bond
Bloomberg Barclays Muni
6.79
US Core Bond
Bloomberg Barclays US Agg
0.19
US High Yield
Bloomberg Barclays US HY
-1.16
Emerging Markets
MSCI EM
-7.09
Developed International
MSCI EAFE
-8.69
US Small Cap
Russell 2000
5.41
US All Cap
Russell 3000
-0.91
US Large Cap
DJIA
5.57
1.63
1.23
0.62
4.24
9.56
4.80
4.93
9.21
8.22
8.93
US Large Cap
S&P 500
3Q
-17.76
4.09
6.98
2.81
10.54
0.49
0.39
15.00
5.70
15.15
1Y
YTD
Index
While it is too early to be waving the all-clear flag just yet, and there will certainly be some more difficult times (and headlines) ahead—as the virus takes its human toll and the economic data deteriorates further—there is light at the end of the tunnel, and this shock will ultimately prove to be temporary.
In the meantime, our utmost concern is for you and your families and our hope is that you are safe. The need to communicate with one another is more powerful than ever. We continue to ask you to keep in touch, especially now, and to reach out to us with whatever questions you may have as we navigate through this together. Thank you for your trust.
Wealth Planning Tip and Philanthropy Strategy Resources:
President Trump signed the Coronavirus Aid, Relief, and Economic Security Act, “the CARES Act,” into law on Friday, March 27. This legislation is aimed at providing relief for individuals and business that have been impacted by the coronavirus outbreak. A brief summary of the CARES Act along with additional tax filing and payment relief provisions can be found here: William Blair: CARES Act. William Blair is monitoring the impact of COVID-19 on the nonprofit sector and the philanthropic activities around the globe and in our local communities to support relief efforts: William Blair: COVID-19 Philanthropy Resources.
MSCI US REIT
Bloomberg Barclays Muni
Bloomberg Barclays US Agg
Bloomberg Barclays US HY
MSCI EM
MSCI EAFE
Russell 2000
Russell 3000
DJIA
S&P 500
1.63
1.23
0.62
4.24
9.56
4.80
4.93
9.21
8.22
8.93
3Q
-17.76
4.09
6.98
2.81
10.54
0.49
0.39
15.00
5.70
15.15
1Y
-17.12
3.33
6.79
0.19
-1.16
-7.09
-8.69
5.41
-0.91
5.57
YTD
Index
Source: Bloomberg
DJIA