In late October, my neighborhood usually springs to life as families prepare for the arrival of throngs of trick-or-treaters. This year, however, rather than hanging up ghosts, spider webs, and other spooky decorations, many of my neighbors hung out signs saying, “Sorry, we’re closed for Halloween.”
The subdued tone of Halloween 2020 was a small reminder of the fact that the coronavirus pandemic remains in an acute phase. Rising COVID-19 infection rates at home and abroad have led authorities to impose new restrictions on business and social activity — albeit mostly at a local level — a trend that spooked many investors last month. In late October, the CBOE Volatility Index (VIX), which measures investors’ expectations for future volatility, climbed to its highest level since mid-June.
Politics also took center stage as the U.S. entered the home stretch of the presidential election. The final weeks of any presidential election campaign are often characterized by investor anxiety and market volatility. This year, however, headlines surrounding the prospect of a contested election only added to the angst.
And yet, as I wrote this commentary, President-elect Joe Biden appeared to win the presidential race, which was much closer than recent polls had predicted. Even before the final votes were counted, President Trump mounted challenges in several states.
Meanwhile, the “blue wave” that many polls had predicted seemed destined to be a wash out. In congressional races, Democrats retained control of the House. While Republicans are currently ahead in the Senate race, we won’t know the results until the new year. What would another divided government mean for the U.S. economy and the stock market? While we cannot predict what will happen, we will explore that question below and continue to monitor the evolving political situation.
After posting strong gains in the late spring and summer, the broad U.S. stock market, as measured by the S&P 500 index, lost ground in October, as it did in the prior month. Nonetheless, the market remained in positive territory for the year-to-date and trailing 12-month periods through last month.
Why did the market suffer another setback? Rising COVID-19 infection rates appeared to overshadow a number of positive developments, including continued improvement in the U.S. labor market and better-than-expected corporate earnings in the third quarter. According to a FactSet release:
According to FactSet, returns for the month of October were negative across almost all S&P 500 sectors.
As we reflect on the tumultuous past year, one of the trends that stands out is the dispersion of returns across S&P 500 sectors. Consider, for instance, the vastly different performance of Technology and Energy.
With many Americans hunkering down at home, the demand for video conferencing, streaming, and social media services has skyrocketed. Tech companies have generally benefitted from this demand. Technology lost ground in October, but had gained a whopping 35.3% for the trailing, 12-month period through Oct. 29.
The pandemic has led to a historic drop in leisure and business travel, which, in turn, has contributed to an imbalance between supply and demand for oil. And with COVID-19 cases rising again, many investors remain concerned about the outlook for Energy. The sector declined by nearly 8% last month (as of Oct. 29) and by slightly more than 48% for the trailing, 12-month period through the same date. Late in the month, its weight within the S&P 500 stood at a historic low of just 2% of the index.
Returns across the U.S. bond market were essentially flat in October, even as stocks trended lower.
Stock-market volatility and/or an uncertain economic outlook can often result in a so-called flight to safety, as investors rotate out of equities and into bonds, pushing up bond prices and driving down yields. (Bond prices and bond yields move in opposite directions.) In October, some investors worried that political gridlock in Washington D.C. would halt another round of fiscal stimulus, while others worried that a substantial stimulus package would drive up government spending.
Ultimately, conflicting investor sentiment towards bonds pushed the broad fixed-income market — as measured by the Bloomberg Barclays U.S. Aggregate Bond Index — into slightly negative territory for the month of October. Nonetheless, the index stood in positive territory for the year-to-date and trailing 12-month periods through last month.
The Economy and the Election
Like a kid who’s binged on Halloween candy, the U.S. economy came roaring back in the third quarter, supported by the swift and aggressive monetary and fiscal stimulus rolled out last spring. In October, the Commerce Department reported that in the third quarter gross domestic product (GDP) — the sum of all goods and services produced within the country — grew by 7.4% over the previous quarter and at a historic 33.1% annualized rate.
Third-quarter growth was stronger than many economists had expected and consistent with recent improvements in the job market and certain critical sectors:
While we expect the U.S. economy to continue to improve, we believe the pace of growth is likely to slow this quarter without the sweetening effect of another round of fiscal stimulus. The recent spike in COVID-19 cases may also have a chilling effect on economic activity.
As of Nov. 9th, ISG expected GDP to grow by 3.9% in the fourth quarter and to decline by -3.5% in 2020 on a year-over-year basis. ISG expects GDP to grow by 5.1% in 2021. Its forecast is driven by optimism surrounding more-extensive COVID-19 testing across the U.S. and more effective therapies, a high likelihood that an effective vaccine will be widely available in the first half of 2021, and the assumption that the pandemic won’t result in new broad shelter-in-place mandates.
In the weeks leading up to the November election, many pundits were forecasting a Democratic sweep of the White House and Congress, or a “blue wave.” Instead, it appears as if we’ll continue to have a divided federal government next year. What does this mean for an economy that has still only partially recovered from the pandemic-induced downturn? Even with robust growth in the third quarter, ISG still expects full year growth for 2020 to come in at -3.5%.
Under a divided government, the next fiscal stimulus package may be more modest than the roughly $2 trillion package many pundits were expecting in the wake of a “blue wave.”
At the same time, a divided government would lower the chances of significant changes to the tax code or a large increase in infrastructure spending — both of which President-elect Biden has proposed — and new regulations on such sectors as Technology. It’s also worth noting that we’re unlikely to see significant changes to the health care landscape under Biden, who has vowed to expand on the Affordable Care Act.
In the first days after Election Day, the stock market largely shrugged off the still-uncertain outcome as a handful of states continued to count votes. But, as discussed during our recent Private Roundtable on the election, a prolonged contested election could contribute to market volatility.
We recommend clients ride out any interim volatility and remain focused on their long-term financial goals. As our ISG colleagues noted in a recent report on navigating market volatility through U.S. elections, actual market reaction can often run counter to prevailing fears. In 2016, as election results the evening of Nov. 8 pointed to an unexpected Trump victory, S&P 500 futures plunged -5% and triggered exchange rules that limit down levels. Yet when investors shifted their focus from the prospects for acrimonious trade policies to the likelihood of market-friendly tax cuts and deregulation, the S&P 500 reversed its losses and ended the next day with a gain, according to the ISG report.
As always, if you have concerns about the markets or your portfolio, don’t hesitate to reach out to your financial adviser.
Invest well and stay healthy,
Kara Murphy, CFA
Chief Investment Officer
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S&P 500 Index: A broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a capitalization-weighted, unmanaged index that is calculated on a total return basis with dividends reinvested. The S&P 500 represents about 75% of the NYSE market capitalization.
Russell 2000 Index: This index measures the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks; the index serves as a benchmark for small-cap U.S. stocks.
MSCI Europe, Australasia, and Far East (EAFE) Index: This index 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.
MSCI Emerging Markets Index: This index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. As of June 2009, the MSCI Emerging Markets Index consisted of the following 22 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
Bloomberg Barclays U.S. Aggregate Bond Index: This is a market capitalization weighted bond index of investment-grade, USD-denominated fixed-income securities.
U.S. High Yield Corporate: The Bloomberg Barclays U.S. Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded.
U.S. Investment Grade Corporate: The Bloomberg Barclays U.S. Corporate Bond Index measures the investment-grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non-U.S. industrial, utility, and financial issuers.
Bloomberg Barclays Municipal Bond Index: The Bloomberg Barclays U.S. Municipal Index covers the USD-denominated, long-term, tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.
S&P 500 GICS Sectors Level-1: In 1999, MSCI and S&P Global developed the Global Industry Classification Standard (GICS) to offer an efficient investment tool to capture the breadth, depth, and evolution of industry sectors. GICS is a four-tiered, hierarchical industry classification system. It consists of 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries. Companies are classified quantitatively and qualitatively. Each company is assigned a single GICS classification at the sub-industry level according to its principal business activity. MSCI and S&P Global use revenues as a key factor in determining a firm’s principal business activity. Earnings and market perception, however, are also recognized as important and relevant information for classification purposes and are considered during the annual review process.
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