Quarterly Update

Before we begin, I just want to say that I hope you and your loved ones are well, all things considered, and that your home has survived the recent fires. Its tough out there right now and natural disasters don't help matters at all. One day at a time. Now, on to this week's post...

During the third quarter (Q3) we continued to climb out of the pandemic-induced hole we found ourselves in earlier this year. Broad economic numbers improved, stocks performed well, and bonds held steady. But our economic and financial recovery has continued to be uneven and this adds risk to the outlook.

Here’s a roundup of how major markets performed during Q3 and year-to-date, respectively:

• US Large Cap Stocks – up 9%, up 5%
• US Small Cap Stocks – up 5%, down 7%
• US Core Bonds – 0.4%, up 7%
• Developed Foreign Markets – up 5%, down 7%
• Emerging Markets – up 10%, down 1%

Tech stocks continued to lead the way during Q3, with the largest companies getting larger. According to Bespoke Investment Group, the five largest stocks in the S&P 500 (Apple, Microsoft, Amazon, Google, and Facebook) now account for nearly 23% of the index’s value. This is radically different from ten years ago. Back then only Apple and Microsoft made the top five and were joined by Exxon (then the largest company), Berkshire Hathaway and Walmart. Those top five made up only 11% of the index’s value in 2010. Now we’re relying more heavily on so-called Big Tech to drive market performance, making diversification harder.

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While still up year-to-date, core bonds were flat for the quarter, rising not quite half of one percent. In August the Fed announced it will manage average inflation versus trying to hit a fixed target at a given point in time. The idea is to let the economy run hotter for a while to compensate for cooler periods, even at the cost of higher inflation. This, plus guidance about keeping short-term interest rates near zero until 2023, led investors to buy bonds during the quarter, and helped to drive down already low rates. The benchmark 10yr Treasury hovered around .65% during Q3 but many investors still favored bonds over stocks.

After falling by around a third during the second quarter, GDP is estimated to have risen over 20% during Q3. Unfortunately, growth stalled toward the end of the quarter as extra federal unemployment benefits expired and the pace of hiring slowed. The Fed and others have been hammering Congress for more fiscal help since there’s a limit to what monetary stimulus (low interest rates, lending programs, and so forth) can accomplish on its own.

Unemployment ended the quarter at 7.9% and underemployment, which includes folks who are working less than they hope to, is almost 13%. Both metrics had been showing improvement but slowed during Q3 after the bounce from historic lows in the second quarter. As Q3 ended, we had only added back about half of the jobs lost across our economy during the pandemic. It’s looking like we won’t get back to a pre-Covid jobs environment until well into 2022 or longer. According to JPMorgan, some sectors are doing better than others at adding back jobs. Financial Services has added back about a third of jobs lost while Trade, Transportation and Utilities has brought back nearly 60%. Leisure and Hospitality (the sector with the most job losses) has only brought back 50%. This employment picture seems incongruous with some business metrics coming in strong and having a positive outlook. The ISM composite of services and manufacturing sectors continued to show expansion throughout the quarter, for example.

An economic bright spot during Q3 was residential real estate. Tight supply nationally coupled with pent up demand and extremely low mortgage rates caused pending home sales to rise almost 9% in August. Prices in some areas were up dramatically over the year prior and September is expected to have been strong as well. The so-called wealth effect from home price appreciation could help bolster consumption as the employment picture remains challenging.  

As we begin the fourth quarter, President Trump has tested positive for Covid and this is seen as a major shift in election news but not necessarily outcome, at least according to betting and financial markets. Vice President Biden has held a stable lead for months and now investors seem to be assuming a sweep by the Democrats in November. For investors, this scenario equals more economic stimulus faster and has helped support markets in recent weeks as the broader recovery has shown signs of slowing.

While the fourth quarter has historically been the best of the year, it’s likely to be volatile. This could come from a long list of issues, including further slowing of the recovery, so it’s best to stay diversified and trust in your allocation plan.

Have questions? Ask me. I can help.