By Daniel McGarvey, Junior Analyst
It goes without saying that 2020 has been a wild ride, but in some ways, the third quarter has been a breath of fresh air as businesses safely reopened. Sports returned, students are learning again, and markets have calmed down compared to the first two quarters. A faint sense of normalcy has begun to seep back in.
Of course, it would be naïve to assume everything will be smooth and rosy for the rest of the year. COVID and its implications are not behind us yet, and, perhaps most importantly, we face a pivotal, divisive election where almost no outcome would be surprising.
Before moving forward, let’s take a look at where we’ve been this past quarter. The S&P 500 gained around 13% in the first two months and then lost 5% in September, leaving the quarter with a gain of around 8%.
This was largely due to the five FAAMG (Facebook, Amazon, Apple, Microsoft, and Alphabet’s Google) stocks that drove the post-March rally finally starting to lose some steam in September, although they still make up almost a quarter of the S&P. The Aggregate Bond Index ended essentially flat, and the Federal Reserve decided to keep interest rates steady in the 0-0.25% range, possibly until 2023.
Volatility measures like the VIX started to calm down compared to the first quarter as well, and unemployment came down to 7.9% after the 14.6% high in April. In general, financial conditions have improved over the quarter, largely due to stimulus measures, income growth, and a gradual increase in consumer spending. The stimulus seems to be outweighing all other factors, however, especially with regard to boosting the uptrend of the markets.
One big takeaway from the third quarter is that the investing landscape has changed. For example, it is difficult for investors to find yield in low-risk assets with interest rates near zero. This is causing money to flow into higher-risk assets in order to increase yield despite the increased uncertainty.
Furthermore, all the government money pumped into the system through stimulus and monetary policy raises concerns about whether inflation could rise substantially and cause further weakening of the U.S. dollar, and there is still the potential for more stimulus money to come if Democrats and Republicans can reach a deal.
While inflation is not expected to skyrocket soon, the possibility of a material rise within the coming years is hardly out of the question, especially when the Fed has admitted considering such unconventional measures as capping treasury yields.
While capping yields seems unlikely at this point, the yield control discussion itself speaks to the extent to which the Fed wants to bolster the economy and the capital markets. This measure hasn’t been implemented since the World War II years when it led to inflation of over 17%. While a significant increase in inflation is certainly a concern, there will have to be at least some consequences for the actions taken to help the economy recover.
Overall, the economy continues to improve, and consumer confidence has rebounded from the dire lows earlier in the year. However, these positive signs are still overshadowed by continued COVID restrictions that impede the full recovery. In a sense, we all feel like we’re waiting for what comes next, especially after the election, and the markets are experiencing this waiting game as well.
They have calmed down a little bit compared to earlier this year, but any number of factors could combine to spur volatility again. The markets do look forward, but that doesn’t mean they’re a crystal ball.
If we can learn anything from 2020 thus far, it’s that anything can happen and not everything can be priced in.
Daniel is a Junior Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.