October 2020 Monthly Market Review
October was characterized by the push and pull between optimism and reality. Risk assets such as emerging markets (EM) equities, EM debt, and high yield bonds delivered positive results as investors sought to look beyond a post-U.S. election and post-pandemic world. U.S. bond yields rose, putting pressure on Treasuries, as markets appeared to expect some form of stimulus to be implemented in the future, regardless of the outcome of the presidential election. However, rising COVID-19 infection rates in the U.S. and Europe prompted partial lockdowns in some countries and led to declines in U.S. and international equity markets.
Rising COVID-19 cases in the U.S. weighed on investor sentiment and risk appetite domestically. The Russell 3000 Index posted its second consecutive monthly decline, losing 2.2%. The traditionally defensive utilities (+4.7%) sector posted was the best performing sector in October. IT (-4.4%) was the worst performing sector, pulling back after strong gains earlier in the year. The drawdown in IT helped value stocks finish ahead of their growth counterparts for the second consecutive month; the Russell 3000 Value Index declined 1.0% versus 3.2% for the Russell 3000 Growth Index. Large cap stocks finished behind their mid and small cap counterparts for the month, but remained ahead year-to-date.
October was a particularly difficult month for developed non-U.S. markets, which fell 4%. Weakness was concentrated in Europe, which also grappled with a resurgence in infections, resulting in newly imposed lockdown measures. The U.K. (-5.1%), France (-4.8%), Germany (-10.3%), and Belgium (-6.0%) were among the countries that announced new restrictions in October. The recent spike was a notable setback, as countries across the continent appeared to have reined in the virus and showed signs of an economic rebound.
Emerging markets were more resilient, besting their developed counterparts with a positive return of +2.1%. China (+5.3%) was again a top performer as it did not experience a resurgence in coronavirus cases and continued on the road of economic recovery. EM leadership remained narrowly focused in tech/e-commerce giants Tencent (+15.5%) and Alibaba (+3.6%). Alibaba’s 33% stake in Chinese fin-tech giant Ant Group helped propel its share price to record highs toward the end of the month. Ant Group was set to list November 5th in what was to be the largest IPO in history, but was suspended by Shanghai and Hong Kong exchanges (where it was set to list) subsequent to month-end. Among other major emerging markets, Taiwan (+1.3%) was a strong contributor, driven by strength in the semiconductor space, where stocks were buoyed by a continued trend towards supply chain diversification away from the United States.
Long-term Treasuries fell 3.0% and those in the 5- to 10-year part of the curve declined 1.0%. Yields rose across the term structure and the curve underwent a bearish steepening with the rise in longer-term yields exceeding those at the front-end. By month-end, the growing consensus was that there would be more fiscal stimulus to counter the economic damage from the pandemic regardless of the election. Rising Treasury yields reflected expectations that an already sizeable U.S. deficit will likely increase further and lead to more Treasury issuance.
Credit spreads tightened, but only the decline in high yield spreads fully absorbed rising Treasury yields. High yield spreads fell 8 bps to 509 bps over comparable Treasuries. The combination of a higher coupon rate and higher starting spread level allowed high yield bonds to return 0.5% during the month. Although only a small percentage increase, high yield outperformed the 0.2% decline of investment-grade corporates, which experienced a greater fall in spreads—11 bps to 125 bps—but failed to fully absorb rising rates.
Real asset sectors followed a similar pattern as developed equities, with REITs (−3.3%) and resources (−4.5%) falling during the month. REITs fell on rising COVID-19 case counts and renewed lockdowns in Europe (−4.9%) and the U.S. Traditional office and brick and mortar retail underperformed while “new economy” or growth sectors generally outperformed, including industrial, data centers, self-storage, and single-family, for-rent, and manufactured housing. Traditional apartment REITs slightly outperformed during the month, but the sub-sector is down 28% year-to-date. Asking rents in major cities have declined materially year-over-year due to the general downturn, and out-migration to nearby suburbs and Sunbelt markets, as many office employees continue to work remotely. Despite near-term and potentially medium-term headwinds, the long-term outlook for the sector appears stronger with secular demand, population growth, and the significant cost discount of renting versus owning.
Natural resource equities fell on lower oil prices (−2.3%) and another quarter of negative earnings for a number of the major integrated oil companies, many of which are not profitable at current commodity prices. Midstream energy equities advanced 5% during October, but remained down 44.3% for the year and the Alerian MLP Index’s aggregate dividend yield now stands at 13.1%, a multi-year high. Elsewhere in resources, industrial metals (+3.0%) and agricultural commodities (+3.9%) moved higher on improved demand from China, which is the largest consumer of these commodities.
Uncertainty Surrounds U.S. Election
Election rhetoric tends to label each election as “the most consequential election in our lifetime.” There is no doubt, however, that the 2020 election will have important ramifications for capital markets. From the outset, there was an unusually high level of uncertainty as nearly 100 million mail-in votes were cast prior to Election Day. Pre-election models showed a significant likelihood of a Democratic sweep, but this did not occur. After days of uncertainty and tallying, the AP declared Joe Biden the victor of a tightly contested race. However, President Trump has yet to concede victory and continues to contest the results. Recounts, as well as potential legal challenges, are expected in the coming weeks.
Control of the Senate remains uncertain. Republicans and Democrats each have 48 Senate seats as of November 9th, with four seats in flux. Republicans are widely expected to hold outstanding seats in Alaska and North Carolina, but neither race has been called. The remaining two seats from Georgia are set for a January runoff, which would determine whether Congress is split or Democrats control both houses (Vice President-elect Kamala Harris would serve as tiebreaker in the Senate).
Domestically, the immediate market response was a change in leadership from value to growth. U.S. value stocks outperformed their growth counterparts in September and October as investors positioned for robust fiscal stimulus, with the base case of Democrats taking over the presidency and Congress. This trade showed signs of reversal in the aftermath of the election as the future of the Senate became more uncertain.