Market Commentary Q3 2020

Global equity markets continued their recovery in the third quarter of 2020.

The S&P 500 index (U.S. Large Cap stocks) finished the third quarter up almost +9% and set a new record in the process. Year-to-date through September 30, the S&P 500 is up +5.6%. The largest technology companies comprise almost 25% of the index and drove returns. For example, Inc. is up +70.4% year-to-date while Apple Inc. is up +58.6% year-to-date. Other index components have more room to go to recover their losses from earlier in the year. Assuming every holding in the S&P 500 has equal weight, the index was up +6.8% for the quarter but down -4.8% year-to-date. U.S. Small Cap stocks gained +5% for the quarter. Equity gains were not limited to U.S. stocks, as Foreign developed (Europe and Japan) stocks were up almost +5%. Emerging market stocks outperformed their U.S. and foreign developed counterparts during the quarter, gaining +9.6%. A continued weakening of the U.S. dollar (-3.6% for the quarter) boosted Foreign stock returns. Non-investment-grade (i.e., high yield) U.S. corporate bonds continued their recovery, gaining almost 5% during the third quarter.

Finally, U.S. Core and International bonds were up +0.6% for the quarter. The 10-year Treasury yield barely nudged during the quarter, ending at 0.68%.

Here are the broad index returns through the Third Quarter of 2020*:

U.S. Large Cap Stocks +5.6% U.S. Real Estate -17.9% Allocation 30%-50% Equity +1.0%
U.S. Small Cap Stocks -8.7% U.S. Aggregate Bonds +6.8% Allocation 50%-70% Equity +1.3%
Foreign Developed Stocks -7.1% International Bonds (Hedged) +3.0% Allocation 70%-85% Equity -1.3%
Emerging Market Stocks -1.2%

What does the BFA Investment Committee think will drive volatility for the rest of the year?

We expect market volatility to pick up as we get closer to the U.S. Presidential and Senate elections. The markets do not like uncertainty, and the election results may not be final until days or months following the actual voting. While the markets may react negatively to these developments, we believe the reaction will be short-lived. Research shows that the political party in power, either in the Presidential or Congressional branch, is not a major market driver. We also expect an increase in market volatility if the U.S. government does not provide further fiscal stimulus. Chairman Jerome Powell of the U.S. Federal Reserve has been quite vocal about the fragility of the economic recovery and the need for ongoing fiscal stimulus in addition to the monetary stimulus provided by the Federal Reserve. Many investment analysts and economists expect Congress to reach a deal, even if it means doing so after the election.

Volatility could also pick up if the global economy, particularly the U.S., cannot sustain the recovery.

Most economists expect a significant bounce in third-quarter U.S. Gross Domestic Product (GDP). Still, there is concern that employment will not reach pre-pandemic levels for several years, and thus, consumer spending will taper off. However, the Federal Reserve has promised to continue its extremely supportive monetary policy. Global governments and central banks have learned valuable lessons from their initial responses to COVID-19 and should continue to act expeditiously to support their economies. Finally, work continues on a COVID-19 vaccine. Although there is uncertainty around when and how the vaccine will be safely distributed worldwide, unprecedented cooperation between global governments and private corporations has given both citizens and investors hope for economic activity accelerating to pre-pandemic levels. Given these challenges and opportunities, your BFA Investment Committee is cautiously optimistic and maintains its portfolio allocations and fund line-up. We are currently holding cash in place of U.S. high yield bonds, and it could be early next year before we re-enter the U.S. high yield corporate bond sector.

We will increase our focus on tax planning in the fourth quarter for client portfolios. Mutual funds are required to distribute their realized capital gains by year-end, with most of those distributions occurring in December. We will analyze our client holdings for material distributions (i.e., 5% or more of net asset value) and may take action to avoid those distributions. We will also look for opportunities to harvest further capital losses in client portfolios. Given the specter of higher capital gain taxes, loss carryforwards have become even more valuable. These actions could save on taxes for you.

You Are Not Alone

Is there any question that “The Year 2020” will go down as one of the most challenging times in history? Certainly not. But you may wonder why you feel so out of sorts. You should know that most of us are experiencing a nagging sense of disorientation about ourselves and the world around us. It is with good cause.

Consider the stressors we are all experiencing: The pandemic is resurging in many states when we thought the worst was behind us. Most of us are beyond tired of social distancing, and the uncertainty surrounding an effective vaccine seems to add little hope. To add insult to injury, the economy has suffered tremendously under the weight of social distancing strategies, is showing timid signs of recovery and there are millions out of work. While you may not personally experience it, you know it is there and you can feel it.

And now the election is here. The current state of politics in America creates its own burden of mental uncertainty. Deep inside, we all know that there are many things that need fixing in the U.S. and are eager to get something done. But collaboration is difficult in a winner-take-all, zero-sum game. Is there any real solution?

More than any other time, you should know that there is hope. In difficult times, you will hear people seek hope by quoting the Bible saying, “This too shall pass.” While somewhat accurate in sentiment, the phrase is not actually in the Bible. However, there is a scripture that says, “Rejoice in hope, be patient in tribulation, be constant in prayer.” Tribulation is inevitable but we can celebrate in that true hope of a better future; chances are, you are among the fortunate ones now. With patience (and a little time) we WILL see it pass. And through prayer, all of us can find peace, compassion, grace and, of course, hope.

Most of all, we need to care for one another, and we want you to know that we care about YOU. If you are inclined to get in touch and share your uncertainties about the future, we can promise a deep interest in your situation and your concerns. We may not have all (or any) of the answers. But there are times when a good conversation about what is important in life can result in better insights, and sometimes, a sense that we are not alone in our uncertainties.

We look forward to talking with you again soon!

*U.S. Large Cap=S&P 500, U.S. Small Cap=Russell 2000, Overseas Stocks=MSCI EAFE, Emerging Market Stocks=MSCI Emerging Markets, U.S. Bonds=Barclays Aggregate Bond Index, International Bonds=Barclays Global Aggregate ex-U.S. USD-Hedged, US Real Estate=MSCI US REIT: Data Source: Morningstar®. Allocations=Morningstar® U.S. Fund Allocation Categories: Data Source: Morningstar®. Index returns are for illustrative purposes only and do not represent actual performance of any investment. Client returns will differ from the results shown. Index performance returns do not include any management fees, transaction costs or expenses. The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate; thus an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than return data quoted herein. Indexes are unmanaged and one cannot invest directly in an index. Please review your allocation regularly and notify BFA immediately if your circumstances should change. The foregoing content reflects the opinions of BFA and is subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct.