September 2020 Monthly Market Review

Special purpose acquisition companies (SPACs) remained in high demand in September as investors sought new ways to participate in a changing landscape for merger and acquisition (M&A) transactions and IPOs.  Outside of SPACs, however, risk appetite waned across markets.  Global equity markets declined, with the U.S. equities trailing both developed international and emerging markets (EM) equities.  Value stocks, which have lagged their growth counterparts for 11 straight quarters, outpaced growth stocks during the month, but the impact across geographies was mixed.  Real assets—from commodities to real estate—were under pressure during the month.

SPACs are publicly traded companies structured to acquire private companies looking to go public.  SPACs provide an efficient means to list a company and provide liquidity to the existing owners, which frequently include private equity firms.  Some of the more notable SPAC transactions in 2020 included DraftKings, Nikola, and Virgin Galactic.  Year-to-date (YTD) through September 30th, 127 SPACs went public with gross proceeds totaling $48.7 billion, which exceeds the total gross proceeds for the six previous calendar years combined ($45.0 billion from 2013–19).  The reason for this is favorable market conditions, including strong performance and investor interest in tech and growth-oriented companies, as well as low interest rates and a lack of traditional IPOs and M&A activity.  SPACs generally have two years to make a deal after going public.

The SPAC boom has implications for a variety of asset classes, the most notable being private equity and hedge funds.  Many of the most prominent issuers of SPACs are well-known private equity firms seeking strategic acquisitions.  In addition, private equity and venture managers are actively taking advantage of demand from SPACs to partially monetize investments at elevated valuations.

Event-driven hedge funds are attracted to the unique SPAC structure as it creates risk arbitrage trading opportunities for event-driven managers.  Some hedge funds have issued their own SPACs (Pershing Square issued the largest SPAC at $4 billion, but has yet to find an acquisition target).  The newly formed public companies created by SPACs are also providing interesting long and short investments for hedge funds and equity managers.

SPAC issuance is likely to remain elevated over the coming months as conditions remain accommodative. However, increased market volatility and economic uncertainty may slow the rate of issuance.  In addition, investors may begin to push back on the terms of SPACs, which are increasingly favoring the issuers rather than the investors/shareholders.

Despite the exuberance around SPACs, global equity markets declined in September.  In the U.S. the Russell 3000 declined 3.6%.  As previously noted, value stocks outpaced growth stocks by 200 bps, snapping an 11-month streak of growth outpacing value.  Despite these dynamics, growth stocks are still outperforming value stocks by nearly 4,200 bps for the one-year period ended September 30, 2020.

Weakness in mega cap growth stocks, particular the FAANGMs, were one reason for growth’s underperformance.  Stocks like Apple (-10%), Facebook (-11%), and Alphabet (-10%) were down double-digits while Amazon (-9%) and Microsoft (-7%) also lagged the broader market.  Even with these losses, the FAANGMs continued to represent over 23% of Russell 3000 Index assets at the end of the month. Specific to value, energy was the worst performing sector, posting a double-digit loss and continuing its trend of becoming a smaller weight in the Index, losing nearly half its value YTD.  Among the other sectors, technology, communication services, consumer discretionary, and financials were notable laggards, while utilities, industrials, and materials held up better than the broader market.

Outside the U.S., markets were down but somewhat more resilient. Developed non-U.S. equities fell just 1.0% in local terms (−2.6% when accounting for U.S. dollar strength).  This was in part attributable to market composition and the sectors that make up the investable universes.  The MSCI EAFE Index is more diversified and has significantly less exposure to large technology and e-commerce companies than the

prominent U.S. benchmarks, and in turn did not face the same headwinds.  Technology accounted for 8.4% of the EAFE Index at the end of the month compared to 28.2% for the S&P 500.  International markets also did not experience the same reversal in style leadership for the month, as value (−4.6%) again lagged growth (−0.7%).  Energy (−13.7%) fell as oil prices declined, while financials (−7.9%) came under pressure from concerns of a second wave of coronavirus across the U.K. and parts of Europe.  Weakness in these sectors drove the 2,300 bps spread between value and growth YTD.

EM equities fell 1.6% and outperformed their developed markets counterparts.  Unlike in U.S. equities, stylistic leadership persisted as the MSCI EM Growth Index fell 1.0%, which compared favorable to the 2.3% decline of the MSCI EM Value Index—driven by continued strength of the IT and consumer discretionary sectors.  Market leadership remained narrow across EM and the large benchmark constituents within these sectors—Alibaba (+2.4%), Taiwan Semiconductor (+3.4%). and Samsung Electronics (+10.1%)—continued to drive returns.  Financials, which represent nearly one-third of the MSCI EM Value Index versus an approximately 8% weight in the MSCI EM Growth Index, was a laggard and weighed on results.  Cyclical segments such as energy—the worst performing sector—also struggled to keep pace with the broad market.

Within real assets, natural resource equities (−9.6%) and master limited partnerships (–13.6%) sharply underperformed on lower commodity prices (energy commodities fell 9.6%) and concerns around the timing and path of a further recovery in global demand.  Existing containment efforts and pockets of increased COVID-19 infection rates around the globe continued to hold global demand at around 90 million barrels a day versus 100 million per day before the pandemic began.  Resource equities, which have historically been highly cyclical, remained decidedly out of favor, following another period of poor earnings in the second quarter and related writedowns of oil and gas reserves.   Along with clean energy stocks (+7.7%), domestic natural gas pricing was a bright spot within energy.  Natural gas prices, which are sensitive to seasonal and weather-related factors, rose 9.8% on a combination of increased power demand, reduced associated gas production from oil drillers, and optimism that the coming heating season and improving economic conditions could drive prices higher.

REIT stocks declined 3.0%, largely in line with broad equity markets.  Weak returns out of Europe (−3.6%) and the U.K. (−8.8%) were a drag on the global index as COVID-19 infection rates increased and the pound and euro declined.  Generally, new economy or growth-oriented sectors continued to outperform traditional or value sectors.  Significant declines were seen in office (−6.2%), regional mall (−5.7%), and traditional apartments (−4.6%), while industrial, health care, single family for rent, and cell towers all fell only slightly, and self-storage outperformed.

Rent collection rates across REIT sub-sectors have remained resilient since the onset of the pandemic in March.   Unprecedented fiscal and monetary stimulus measures have supported tenants across multiple sectors, from retailers to individual apartment renters.  Despite the expiration of federal unemployment benefits at the end of July and elevated unemployment rates across the U.S., August and September collections for multi-family remained strong at 96%.  REIT apartments generally serve a population less likely to be impacted by layoffs, at least initially.

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