September Pullback Sees Renewed Focus on Quality
The Consumer Discretionary and Technology sectors helped to fuel the S&P 500 gains during the third quarter.
By Michael Mullaney
Director of Global Markets Research
After five consecutive months of gains, the S&P 500 dropped by -3.80% during September, succumbing to a long list of investor concerns. Among the worries, uncertainty regarding the pace of economic growth, a second wave of COVID infections across several countries and U.S. cities, a bipartisan stalemate regarding an “add-on” coronavirus recovery package and ongoing geopolitical tensions all weighed on equities. The high-beta, tech-laden NASDAQ Index actually entered what is considered to be a “correction” phase during the month, falling by nearly 12% at one point from its September 2 peak, though it was able to recover some of the loss by month end.
Despite the down month, the S&P still managed to post a robust return of +8.93% for the third quarter, boosted by gains in July and August that exceeded 13%. Year-to-date, the benchmark has gained +5.57% on a total-return basis. Only two sectors posted positive returns during the month: Materials, a classic cyclical sector which gained +1.34%, and Utilities, a stalwart defensive play which returned +1.13%. The pair normally are considered to be strange bedfellows. Given the down month for the market, the gain for Utilities makes sense, while the performance of the Materials sector was due to strength in stocks that benefit from the bipartisan support of forthcoming infrastructure spending.
The biggest laggard for the month was once again Energy, which fell by -14.51%. Both the International Energy Agency and OPEC cut demand forecasts, Libya restarted production, and President Xi signaled that China will be turning away from fossil fuel in favor of renewable energy sources.
The Communication Services, Technology and Consumer Discretionary sectors also suffered during September. This stemmed largely from being the repositories of the FAANMG (Facebook, Amazon, Apple, Netflix, Microsoft, Google) stocks, which collectively lost -8.86% during the month. The pullback was largely due to profit-taking, but also from continued fear of government intervention.
Over the past three months, the Consumer Discretionary sector was the best performer for the quarter, gaining +15.06%. However, the biggest contributor to the overall quarterly gain for the S&P came from the Technology sector, which returned +11.95% but has a weight in the index nearly three times that of the Consumer Discretionary sector.
Energy pulled up the rear for the quarter, dropping by -19.72%, though the bulk of that loss occurred in September.
Renewed Focus on Quality
Given the “risk-off” trading mentality that occurred during September it comes with little surprise that low-quality and high-beta stocks lagged during the month. Stocks in the S&P 1500 index rated “B” or lower by Standard & Poor’s lost -3.36% while those rated “B+” or better fell by -2.51%. The highest beta quintile of the S&P 500, meanwhile, lagged the lowest by some 350 basis points.
Under the “risk-off” conditions, one would think that small-capitalization stocks would be prone to lagging their large-cap counterparts, but that was not the case during September. The Russell 2000 Index lost -3.34% but the Russell 1000 fell by -3.70% and the equal-weighted S&P 500 Index fell by “just” -2.51%. The discrepancy can be sourced to the underperformance of mega-cap tech stocks, which carry a significant weight in the large-cap indices.
From a style standpoint, the underperformance of mega-cap-tech stocks helped boost the relative performance of large-cap Value versus large-cap Growth during the month. The Russell 1000 Value Index fell by -2.46% versus a loss of -4.70% posted by the Russell 1000 Growth Index. However, in the mid- and small-cap segments of the Russell style indices, Growth beat Value by an average of 169 basis points.
The international bourses outperformed the U.S. market during the month, losing less in both local currency and U.S. dollar terms. In local currency terms the MSCI EAFE Index dropped by -0.95% while the MSCI EM Index fell by -1.63%.
Returns outside the U.S. were helped by a lower exposure to the global technology sector sell-off, as EAFE maintains a tech sector weight of only 8.4%, while the MSCI EM index carries a moderate 17.5% tech weighting. The S&P 500, in contrast, has a tech weight of 28.7%.
In $USD terms, returns were lower for EAFE (-2.55%) as the dollar gained over 2% on average during September against a basket of G10 currencies, a reflection of its “safe haven” status during turbulent times.
The MSCI EM Index did slightly better in dollar terms (-1.58%) as the greenback lost a little over 1% on average to the South Korean Won, the Taiwanese Dollar and the Chinese Renminbi. Collectively, those three countries represent nearly 64% of the country exposure of the EM index.
For the quarter, only the MSCI EM Index in $USD terms outperformed the S&P 500, returning +9.70% with nearly 100 basis points of EM currency gains.
While the Atlanta Fed GDPNow Model is forecasting a Q3 GDP gain of +34.6% on a quarter-over-quarter annualized basis (+7% YOY), recent economic releases indicate that the pace of the U.S. economic recovery is beginning to lose some momentum. Gains in the ISM Manufacturing and New Orders Index began to ebb, showing a slower pace of job creation. While still in positive territory, the Citigroup Economic Surprise Index has fallen from a recent peak of 270 on July 16 to 164 on October 2. (A level of 0 would indicate all economic releases matched the consensus forecasts.) Federal Reserve Chairman Jerome Powell has been quite vocal on the need for additional fiscal stimulus to ensure the continuation of the economic recovery.
This is putting additional pressure on Congress to pass some version of a CARES II Act, probably south of the $2.2 trillion package proposed by the Democrats, but north of the $500 billion initial proposal of the Republicans. Negotiations continue between Nancy Pelosi and Steven Mnuchin. President Trump’s contraction of the COVID-19 virus probably increased the odds of a package being passed, at least at the margin. The duration and strength of the cyclical recovery is paramount for the continuation of the recovery in value-based strategies.
Besides the loss of economic momentum, the biggest risk factor facing the market remains the path the coronavirus takes, as the recent back-to-school / back-to-college news seems to be highly correlated with an increased level of infections. The uptick cannot be fully explained by the increase in testing as hot spots are once again increasing in the U.S. and internationally.
Bottom line, until a vaccine or effective treatment is available to the masses, the market will be prone to heightened volatility. In the near-term, this will be exacerbated by the forthcoming election that has begun to resemble a World Wrestling Federation steel cage match.
Published October 2020.
Boston Partners Global Investors, Inc. (“Boston Partners”) is an investment adviser registered with the SEC under the Investment Advisers Act of 1940. Registration does not imply a certain level of skill or training. The views expressed in this commentary reflect those of the author as of the date of this commentary. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Past performance is not an indication of future results. Discussions of securities, market returns and trends are not intended to be a forecast of future events or returns.
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