The U.S. economy shrank at a 31.4% annualized rate in Q2 (most recent available). This was a historic contraction amid the nationwide shutdown caused by the COVID-19 pandemic. The economy is expected to show signs of a recovery in Q3 (the first estimate is scheduled for October 29) as businesses have reopened and millions of Americans have gone back to work; however, there may be a slowdown in Q4 if the surge in new infections continues. The unemployment rate fell to 7.9% in September mainly due to lower labor force participation, but job growth continued to stall. The unemployment rate spiked to its highest level since the Great Depression - more than double its pre-pandemic level. The economy has recaptured over 11 million positions or about half of those sidelined from COVID-19. However, over 10 million workers remain jobless.
Consumer spending is rising, but the recovery is uneven as some sectors remain suppressed. Manufacturing PMI for the U.S. came in at 55.4 in September; the reading is the fourth consecutive month of expansion in factory activity. For the first time in 25 years, durable consumer goods prices turned positive pointing toward inflation creeping back into the economy. Housing remained the bright spot in the economy, with new home sales reaching their highest level since September 2006. Federal Reserve Chairman Jerome Powell has called for additional fiscal stimulus to support the economy but prospects for additional stimulus remain uncertain as there is a lack of consensus on the appropriate size of another stimulus bill.
The Federal Reserve remains committed to keeping rates near zero as the economy tries to recover. The yield on the benchmark 10-year Treasury ended the quarter at 0.69%. The 30-year Treasury yield ended at 1.46%. High yield and developed international bonds had the strongest fixed income returns in Q3, each jumping 4.4%. Treasuries increased 0.17% and investment-grade corporates returned 1.54%. Mortgage-backed securities had the weakest returns for the quarter, returning 0.11%. The Bloomberg Barclays U.S. Aggregate Bond Index known as the “Agg” returned only 0.62%; its low return is explained by the composition of the index with over 40% of assets in U.S. Treasury bonds and about 25% in both mortgage-backed securities and investment-grade corporates.
The S&P 500 continued its post-March rally into Q3, ending the quarter up 8.9% despite a weak September. This followed the sharp sell-off in Q1 and subsequent rebound in Q2. For the nine months ended 9/30, the S&P 500 increased 5.6%. Since the market lows in March, the S&P 500 jumped over 50%. The market broadened in the quarter. Consumer discretionary, materials, and industrials had the strongest returns, up 15.1%, 13.3%, and 12.5%, respectively; technology increased 12.0%. The worst performing sectors were energy (down 19.7%) and real estate (up 1.9%). Financial stocks also underperformed, increasing 4.5%. In the quarter, growth stocks continued to dominate value, significantly outperforming value stocks across capitalizations, dominating over longer periods. Large caps outperformed small and mid caps across capitalizations and also dominated over longer time periods. The forward P/E for the S&P 500 was 21.5x, above the 25-year average of 16.5x.
Strong quarterly performance wasn’t isolated to U.S. markets. Emerging markets outperformed the S&P 500 with a quarterly return of 9.7%. Emerging markets also outperformed developed international markets in Q3. EM Asia jumped 12.1% while Latin America fell 1.2%. Developed Europe gained 6.0% while Developed Asia gained 5.5%.
The Bloomberg Commodity Index rose by 9% in Q3 given strength from all commodity sectors including natural gas, silver, livestock, industrial metals, gold, and oil. Natural gas prices gained 56% while oil prices inched up to $40/barrel. Gold prices continued to rise reaching $1,896/ounce as a result of safe haven demand. REITs improved by 1.1% in Q3 but came in as the worst-performing asset class for the year-to-date, down 17.9%. Commercial real estate has been hit hard by the pandemic while residential home sales remain strong boosted by low mortgage rates.
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