Equity Markets
U.S. stock indices continued to rebound from the 1Q plunge; the Russell 1000 was up more than 50% from the low reached on March 23. The S&P 500 Index was up 8.9% for the quarter, bringing its year-to-date result to 5.6%. However, returns among constituents painted starkly different pictures. Consumer Discretionary (+15%) was the best-performing sector while Energy (-20%) was the worst. YTD, a handful of sectors remain in the red while others are up double-digits. Technology (+29%) and Energy (-48%) share the leader/laggard awards. The pandemic has cast a pall over certain sectors while rewarding others; online retail stocks have soared 60% this year, the home improvement sector is up over 30%, but hotels/cruise lines, airlines, and commercial REITs have dropped over 40%.
A similar and related picture emerges with style indices. The tech-heavy Russell 1000 Growth Index (+13.2%) was again the best performer, and its gain is just shy of 25% YTD. Conversely, the Russell 1000 Value Index was up only 5.6% in the quarter, and it has lost nearly 12% this year. The dispersion between growth and value is near an all-time high and equally stark in small and midcap stocks for both the quarter and YTD. Strong stock performance has been concentrated among a few names in the market. The top five stocks (Facebook, Microsoft, Amazon, Alphabet, and Apple) in the S&P 500 account for 23% of the Index and 33% of the performance. The S&P 500 YTD return would be negative if these stocks were excluded.
Outside of the U.S., equity index returns were positive across developed and emerging markets (MSCI ACWI ex-USA: +6.3%; MSCI Emerging Markets: +9.6%) but both remain down YTD (-5.4%; -1.2%). As in the U.S., growth outperformed value. Among countries in both developed and emerging markets, returns varied widely with some countries posting double-digit gains and others suffering double-digit losses. The U.S. dollar lost ground versus most developed market currencies.
Fixed Income Markets
U.S. Treasury yields held steady over the course of 3Q in spite of strong equity markets and better-than-expected economic data. The 10-year U.S. Treasury yield closed the quarter at 0.69%, up 3 basis points from June 30 but off far more sharply from the year-end level of 1.92%. Its yield hit an all-time low of 0.52% in August. TIPS (Bloomberg Barclays US TIPS: +3.0%) strongly outperformed nominal U.S. Treasuries for the quarter as 10-year breakeven spreads widened from 134 bps to 163 bps. The Bloomberg Barclays US Aggregate Bond Index gained 0.6%, with the corporate and commercial mortgage-backed sectors performing the best. Supply hit record levels as companies rushed to take advantage of ultra-low interest rates. The Bloomberg Barclays High Yield Bond Index was up 4.6% and is now roughly flat YTD. High yield and leveraged loan default rates (5.8% and 4.3% y-o-y as of September, according to data from JP Morgan) continued to trend higher but remain below levels reached in the Global Financial Crisis. Energy and retail sectors have been the hardest hit, with default rates that are approaching 20% for loans and bonds. Downgrades among high yield bonds and loans as well as “fallen angels” (downgrades from investment grade to high yield) reached record levels while recovery rates are near record lows. Separately, municipal bonds (Bloomberg Barclays Muni Bond Index: +1.2%) benefited from favorable supply/demand dynamics.
Broad-based U.S. dollar weakness dampened hedged returns in the quarter. The Bloomberg Barclays Global Aggregate ex-US Bond Index rose 4.1% (unhedged) and 0.7% (hedged). Emerging market debt indices posted solid results (EMBI Global Div: +2.3%; GBI-EM Gl Div: +0.6%) but remain down from year-end (-0.5%; -6.3%).
Real Assets
Real assets returns were mixed in the third quarter. Falling oil prices hurt MLPs (Alerian MLP: -16.3%) while gold (S&P Gold Spot Price: +5.3%) hit an all-time intraday high in August ($2,005/ounce). The Bloomberg Commodity Index gained 9.1% with all sub-components except Energy up sharply. REITs were mixed (FTSE Nareit: +1.4%) for the quarter and YTD performance is striking: Regional Malls (-54%), Lodging/Resorts (-49%), Shopping Centers (-45%), and Office (-30%) suffering from COVID-19 lockdowns while Data Centers (+26%) and Industrial (+9%) saw gains. TIPS (Bloomberg Barclays TIPS: +3.0%) did well as inflation expectations rose from depressed levels. The 10-year breakeven spread widened from 1.34% to 1.63% over the quarter.
