Q3 Market Update & Commentary

Extraordinary policy intervention in the form of multi-trillion-dollar fiscal stimulus and zero interest rate policy has the economy recovering faster than most had predicted and continues to fuel a stock market recovery.  The Federal Reserve Open Market Committee (FOMC) met in late July and again in mid-September.  At both meetings, they elected to leave rates unchanged at the zero-bound, and the Committee pledged to support the economic recovery by setting a higher bar for future rate increases and announcing their expectation to hold rates near zero for at least the next three years.  Thanks to all of these actions, third quarter real gross domestic product (GDP) growth is estimated to be around 30%, one of the best quarterly results in recorded history, and September unemployment fell to 7.9%, down from its recent peak of 15.0%.  Our elected representatives have been unable to come to terms on their next stimulus package as of yet, but Secretary Mnuchin and Speaker Pelosi remain in talks, and market participants do clearly expect additional stimulus to come sooner or later.
 
U.S. stocks followed the dramatic increases of the second quarter with further gains in the third quarter.  Despite a shift in investor sentiment during September, the third quarter still saw new closing records in the S&P 500.  Broadly, the third quarter saw more of the same … with growth stocks besting value, large stocks outperforming small, and U.S. stocks topping international. 
 
The S&P 500, comprised of the largest 500 stocks in the U.S., rose another 8.93% during the third quarter, and pushed into positive territory for the year-to-date period, up 5.57%.  The blue-chip Dow Jones Industrial Average also had a strong quarter, rising 8.22%, but remains in negative territory for the year, down 0.91%.  As noted above, the disparity between growth companies and value (generally split by price-to-book ratios – above average equals growth and below average equals value) has been wide, and it continues to grow.  During the third quarter, the Russell 1000 Growth Index jumped another 13.22%, while the Russell 1000 Value Index rose just 5.59%, a difference of 7.63% in favor of the Growth Index.  Year-to-date, Growth has risen 24.33% compared to Value falling 11.58%, for a Growth advantage of 35.91% over the nine month period.
 
Throughout history, growth and value stocks have gone through cycles of leadership.  Growth stocks have led the way since the financial crisis.  Consistent dividend payers are an important – and often popular – slice of the value stock universe.  The Dow Jones U.S. Select Dividend Index is comprised of 100 U.S. stocks with a consistent history of dividend payments.  Nearly half of the stocks in this particular index are in the Financial and Utility sectors, two of the worst performing sectors of 2020.  Year-to-date, this index has fallen 19.86%.  We will not attempt to predict the exact point at which growth stock leadership will end, but will note that there are many dividend payers that are solid companies with good businesses and investment-grade balance sheets, who are strong enough to navigate a weak economic environment.  Many of these companies are even increasing their dividends during the COVID-19 pandemic because their revenues and earnings are growing, contrary to their stock prices.  Just remember that trees do not grow to the sky, and quality businesses that pay consistent and growing dividends never truly go out of style.
 
As we have discussed in previous comments, the S&P 500, as well as Russell 1000 Growth, have been heavily influenced by the largest stocks in the indices.  The five largest stocks in the S&P accounted for more than 22% of the index at the end of the quarter, and their strong performances this year have propelled the index into record territory.  This heavy weighting for the largest companies is called “market cap weighting.”  The S&P 500 Equal Weight Index (an equal weighting for all stocks in the index) rose 7.54% during the third quarter, versus a gain of 8.93% for the S&P 500.  The equal weighted index is still negative by 2.73% year-to-date, 8.30% behind the S&P 500.  Further evidence of the powerful leadership of the largest stocks is found in the underperformance of the Russell 2000 Index of small cap companies.  The Russell 2000 climbed 4.93% during the quarter, yet remains down 8.69% for the year to date.
 
With the FOMC standing pat on interest rates, Treasury yields were little changed.  However, investor risk appetite was strong, resulting in tighter credit spreads.  The Bloomberg Barclays Aggregate Bond Index (the “Agg”) rose 0.62%, and is ahead by 6.79% for the year.  The U.S. Dollar continued to drift lower versus other global currencies, and this helped strengthen commodity prices.  The Bloomberg Commodity Index jumped 9.07% during the quarter, though it remains firmly in negative territory year-to-date, down 12.08%.  This weak year-to-date performance comes in spite of powerful upward moves in the prices of gold and silver, up 23.89% and 31.48%, respectively.  Index components from the energy group, like crude oil and natural gas, both of which remain quite weak, have a much larger index weighting than do precious metals, and have kept the Commodity Index performance under pressure.
 
The softer dollar and improving commodity prices are both supportive of emerging markets economies, as evidenced by the MSCI Emerging Markets Index’s strong 9.56% quarterly performance.  Emerging Markets remain in the red for the year, though, down 1.16%.  Developed international markets have not kept up with emerging markets, and the MSCI EAFE Index rose only 4.80% during the quarter.  The EAFE remains lower by 7.09% year-to-date.
 
Moving forward, the arc of COVID spread, with cases currently rising again throughout Europe and the U.S., and the path to a vaccine will be carefully monitored.  We noted previously that we expected setbacks and temporary retreats along the way.  According to The New York Times, there are currently eleven vaccines in Phase 3 large-scale efficacy tests and six vaccines approved for early or limited use, with none yet approved for full use.  The November Presidential Election looms large, with an outcome that could potentially shift policy meaningfully.  Investors also worry its outcome could be contested for days or even weeks.  The passing of Justice Ruth Bader Ginsberg stirred up additional political discord, and Amy Coney Barrett’s confirmation hearings will be historic.  While the U.S. economy and job market have shown marked improvements over the past six months, all of these issues and concerns could affect markets in both the short and long terms.  In the face of election and pandemic uncertainty, we continue to encourage our clients to maintain an investment strategy that is guided by their own goals and tolerance for market risk. 
 
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John M. Stone, CFA, AIF^® is First Vice President / Investments at Stifel.

The performance data quoted represents past performance, which does not guarantee future results.  Current performance may be lower or higher than the performance data quoted.  Yields will vary.  Diversification and asset allocation do not ensure a profit or protect against loss.  Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments.  The Standard & Poor’s 500 Index is a capitalization-weighted index that is generally considered representative of the U.S. large capitalization market.  The S&P 500 Equal Weight Index is the equal-weight version, which has the same constituents as the capitalization-weighted S&P 500, but each company in the index is allocated a fixed weight of 0.20% at each quarterly rebalancing.  The Dow Jones Industrial Average (DJIA) is an index that shows how 30 large, publicly owned companies based in the United States have traded during a standard trading session in the stock market.  The Russell 2000 Index measures the performance of the 2,000 smallest companies in the broader Russell 3000 Index, which measures the performance of the 3,000 largest U.S. companies based on total market capitalization.  The average market capitalization is approximately $490 million, and the median market capitalization is approximately $395 million.  The Russell 2000 Growth Index measures the performance of those Russell 2000 index companies with higher price-to-book ratios and higher forecasted growth values.  The Russell 2000 Value Index measures the performance of those Russell 2000 index companies with lower price-to-book ratios and lower forecasted growth values.  The MSCI EAFE Index (Europe, Australasia, and the Far East) is a free float-adjusted, market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada.  The MSCI Emerging Markets Index captures large and mid cap representation across 26 emerging markets countries, covering approximately 85% of the free float-adjusted market capitalization in each country.  The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market.  The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), and ABS and CMBS (agency and nonagency).  The Dow Jones U.S. Select Dividend Index consists of all dividend-paying companies in the Dow Jones U.S. Index, excluding REITs, that meet certain requirements regarding dividend-per-share growth rate, five-year average dividend coverage ratio, five-year dividend payment history, 12-month trailing EPS, and three-month average daily trading volume.  The index is rebalanced annually with constituents weighted according to their indicated annual dividend (not to exceed 10%).  The Bloomberg Commodity Index (BCOM) is calculated on an excess return basis and reflects commodity futures price movements.  The index rebalances annually weighted two-thirds by trading volume and one-third by world production, and weight capitalizations are applied at the commodity, sector, and group level for diversification.  The weightings for each commodity included in BCOM are calculated in accordance with rules that ensure that the relative proportion of each of the underlying individual commodities reflects its global economic significance and market liquidity.  Index returns include the reinvestment of dividends but do not include adjustments for brokerage, custodian, and advisory fees.  Indices are unmanaged and are not available for direct investment.