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- Global equities recorded strong returns as recoveries in many regions proved less sluggish than feared and hopes grew for an early coronavirus vaccine.
- Bond returns were also positive as investors embraced riskier assets, including high yield issues.
- Investors continued to favor firms benefiting from the accelerated shift to an online economy.
Stocks recorded a second consecutive quarter of strong gains, helping push the S&P 500 Index and the Nasdaq Composite Index to record highs in late August. Consumer discretionary shares performed best within the S&P 500, bolstered by healthy sales for some retailers and homebuilders as well as optimism over the reopening of the economy. Materials, industrials, and technology shares were also strong. Energy shares underperformed dramatically, declining nearly 20% in total return (including dividends) terms, as oil prices remained stubbornly low on both production and demand concerns.
Large-caps and growth stocks again outperformed their small-cap and value counterparts by a large margin, despite periodic signs of a market rotation. Investors continued to focus much of their enthusiasm on the internet and technology giants benefiting from the stay-at-home economy, and Apple marked a milestone in August by becoming the first U.S. company with a market capitalization over USD 2 trillion.
Bonds also recorded solid overall returns in the quarter, although Treasuries were basically flat as the yield on the benchmark 10-year Treasury note increased slightly over the period. (Bond prices and yields move in opposite directions.) High yield bonds were especially strong as investors grew less risk averse, allowing the market to absorb heavy new issuance and the arrival of numerous “fallen angels,” or issuers that recently lost their investment-grade (IG) status. Healthy demand in the municipal and IG corporate sectors was also able to absorb increased new supply. The Federal Reserve announced late in the quarter that it would allow inflation to drift above its 2% target as part of an “inflation averaging” program designed to boost the labor market.
Fast Economic Rebound Boosts Sentiment
A faster rebound in the economy than many had expected seemed to play a key role in driving markets higher. In July, the Labor Department reported that employers had added a record 4.8 million jobs in June, and another 3.1 million were added over the following two months. Weekly jobless claims also fell steadily throughout most of July and August, although progress seemed to stall in September. Manufacturing signals were generally strong, as firms sought to replenish inventories depleted in the spring. The much larger services sector also began to expand again in June, although restaurants, airlines, and other industries continued to struggle with coronavirus restrictions and cautious consumers. The housing sector was a standout, with monthly existing home sales hitting a record high, while sales of new homes reached their highest level since 2006.
The bounce in economic activity was widely attributed in part to the record federal stimulus put in place in March and April, leaving many investors to worry about how the recovery would progress as the fiscal impact began to fade. Negotiations continued in Washington over the size and breadth of a new round of stimulus, but markets wavered as no deal appeared imminent by the end of the quarter. Extended unemployment benefits of $600 per week expired on July 31, and the Payroll Protection Program, which extended loans to small businesses to maintain payrolls, stopped accepting applications on August 8.
Pandemic Remains in Focus
Coronavirus news seemed to drive markets throughout the quarter. Investors took a renewed rise in U.S. infections in July largely in stride, but fears in September of a possible “second wave” in Europe (see below) and the U.S. seemed to elicit more concern. Conversely, markets appeared to get a boost from reports of progress in developing vaccines and treatments. By the end of the quarter, 11 vaccine candidates had moved into the final stage of trials in the U.S. and Europe, and hopes grew that the initial distribution could begin as early as the end of the year. (News of President Donald Trump’s diagnosis and treatment for COVID-19 arrived soon after the quarter ended.)
Leaders Agree to EUR 750 billion Recovery Fund
European Union (EU) leaders agreed to a historic deal on a EUR 750 billion stimulus plan. As a result, the European Commission, the EU’s executive branch, can now raise billions of euros in capital markets on behalf of all 27 states. The fund will comprise EUR 390 billion in grants—instead of the proposed EUR 500 billion—and EUR 360 billion in low-interest loans. Reducing the proportion of the fund allocated to grants appeased fiscally hawkish northern countries, which also secured sizable budget rebates to lower their annual net contributions. However, concerns that the fund might be delayed beyond the January 1 target date arose after member states clashed over a proposal that disbursements should be conditional on respect for the rule of law, a stipulation that aimed to bring in line member states that have flouted EU norms.
Germany, France, Italy, and the UK decided to increase already substantial support for their economies, injecting extra funds to bolster jobs and cutting taxes for businesses. France unveiled a EUR 100 billion recovery plan and EUR 20 billion worth of tax cuts over the next two years. Finance Minister Bruno Le Maire said he would extend an emergency furlough scheme beyond 2020 if the economic crisis worsens, suggesting that the government might expand its stimulus measures. Italy said it would increase its support package by EUR 7 billion to EUR 32 billion. The UK announced a scaled-back job program to replace the existing supports that will end October 31, as well as aid for the hospitality and tourism sectors. Germany added EUR 10 billion to its effort to keep workers on companies’ books.
EU Economic Recovery Shows Signs of Stalling
After contracting at record rates in the second quarter, European economies showed signs of a rebound in July and August, stoking hopes for a V-shaped recovery. However, business activity stalled in September, as rising coronavirus infection rates and social distancing weakened demand, especially in the services sector. An early estimate of IHS Markit’s composite purchasing managers’ index (PMI) came in at 50.1, down from 50.9 in August. (A PMI reading of 50 marks the level between expansion and contraction.) The services portion of the index slipped below 50, hitting a four-month low. The manufacturing index, however, reached a 31-month high on stronger exports.
EU Dashes Hopes of Imminent Deal With UK
Tensions flared between the UK and EU after the UK published a draft law to create an internal market after December 31. The EU objected to clauses that would override sections of the withdrawal accord agreed to last year and advised member states to prepare for a no-deal Brexit. The UK government conceded that some clauses would breach international law. The lower house of Parliament then passed the bill, prompting the European Commission to start legal action, just as officials reportedly said both sides had found common ground in some disputed areas during the latest post-Brexit trade deal talks. An EU official later dismissed these claims as “UK spin.”
Japanese stocks produced solid gains and outperformed within the Pacific region and versus the MSCI EAFE Index of developed overseas markets. From a style perspective, as measured by the MSCI Japan Index, growth stocks outperformed value shares, and small‑caps generated stronger gains than large‑caps. The yen strengthened versus the U.S. dollar and closed the period above JPY 105. The yield on 10-year Japanese government bonds drifted lower and ended the period near 0.01%.
Prime Minister Suga Takes the Reins From Abe
As was widely expected, Yoshihide Suga was voted in as Japan’s prime minister by both houses of parliament on Wednesday, September 16. He replaces Shinzō Abe, who is leaving his post due to illness. Suga, who is 71 years old, will fill the remainder of Abe’s term until September 2021.
While the press had intimated that Suga would make wholesale cabinet changes, the new prime minister only added five new members, while key members, including Finance Minister Tarō Asō and Foreign Affairs Minister Toshimitsu Motegi, retained their posts. Suga has stated that his top priorities are managing the coronavirus pandemic and the deteriorating economy. He said that he intends to pursue the monetary and fiscal policies established under Abenomics, which helped ease investor concerns, and that he would not dissolve the lower house for a snap election at this time.
The Japanese Cabinet Office lowered its gross domestic product (GDP) growth forecast for fiscal 2020, which ends in March 2021, to a 4.5% contraction due to the impact of the global pandemic. The latest forecast represents a steeper decline than in fiscal 2008 following the global financial crisis and represents a massive revision from the 1.4% growth forecast six months ago. The dour forecast reflects recessionary conditions and the likelihood of another round of stimulus. Looking ahead to fiscal 2021, the Cabinet Office believes that Japan’s economy will grow 3.4% if the coronavirus is contained and global economic conditions recover to a semblance of normalcy.
Kuroda Discusses the Bank of Japan’s Response to the Global Pandemic
In a webinar hosted by the Center of Japanese Economy and Business at the Columbia Business School on August 5, central bank Governor Haruhiko Kuroda addressed the impact of COVID-19. While Kuroda thinks that Japan’s economy will improve over the remainder of fiscal 2020, as many countries gradually restart their economies, the pace of improvement is expected to be moderate because of coronavirus preventive measures. Kuroda believes Japan’s economy can expand 3% to 4% in fiscal 2021. However, this outlook entails several uncertainties such as a second round of health-related business closures, liquidity and solvency issues, and the potential for faltering sentiment that could lead to a reduction in consumer spending. The governor said the central bank will continue to keep a weather eye on the economic impact of the coronavirus and will not hesitate to provide support for financing and maintaining stability in financial markets.
Chinese stocks began the quarter with a July rally as data revealed that the country’s economy returned to growth in the second quarter but the indexes pared their gains in September amid the global stock market downturn. Chinese stocks experienced a tug of war between positive domestic news (economic recovery, COVID-19 under control) and less positive external news (global second wave fears, U.S. anti-China rhetoric).
Bond yields rose in the quarter, with the 10-year central government bond yielding 3.17%, an increase of 27 basis points. Monetary policy remained on hold while surging central and local government bond issuance and the strong recovery pressured yields. The People’s Bank of China announced reforms to simplify bond account opening and allow foreign investors greater foreign-exchange trading flexibility. Inflows into Chinese bonds hit a record in the quarter as foreign investors were drawn to their relatively higher yields. In September, FTSE Russell announced the inclusion of China in its global benchmark bond indices beginning in October 2021, which could attract substantial passive inflows. The renminbi currency strengthened against the U.S. dollar. The USD/RMB currency pair ended September at 6.79, a gain of 4%. In trade-weighted terms, China’s official currency basket rose by 2.6%.
Government Policies Remain Supportive
Fiscal policy stimulus accelerated in August after the Ministry of Finance ordered local governments to use remaining bond quotas by October, accelerating the disbursement of infrastructure funds. Beijing adopted a new economic development strategy called “dual circulation,” which is expected to play a key role in the country’s next five-year plan. The strategy calls for China to lean on its vast domestic market for economic growth and advances in technology while drawing in foreign investment, with an eye toward reducing the country’s dependence on export-led growth. The strategy, which gained prominence after President Xi Jinping raised it at a Politburo meeting in July, is seen as China’s response to navigating an increasingly hostile world and effectively reduces its reliance on the West.
Recovery Confirmed by Robust Economic Data
China became the first major economy to return to positive growth after the coronavirus outbreak. GDP grew 3.2% year-on-year in the second quarter after a 6.8% fall in the first quarter. Fiscal stimulus measures, global pandemic-driven demand for health care and technology products, and a surprisingly strong recovery in the property market were the main growth drivers.
September PMIs also came in above expectations, pointing toward continuing growth in the fourth quarter. Industrial profits rebounded in the third quarter, which should support demand by allowing manufacturers to replace depleted inventories and resume capital expense plans delayed by the coronavirus. The industrial enterprise profits surveys augured well for third-quarter earnings, as the two series are closely correlated.
Other Key Markets
Souring Investor Sentiment Sinks Turkish Stocks
Turkish stocks, as measured by MSCI, returned -15.61% in U.S. dollar terms in the third quarter versus 9.70% for the MSCI Emerging Markets Index. Weakness in the Turkish lira, which fell 11% versus the U.S. dollar during the quarter, significantly reduced returns in dollar terms.
Investor sentiment toward Turkish assets was hurt by several factors. These included concerns about the Turkish central bank’s depletion of its foreign exchange reserves, a Moody’s sovereign credit rating downgrade, and the lira’s decline to all-time lows versus the U.S. dollar.
In August, the government declared that it was phasing out its targeted liquidity facilities that were established in March to stimulate credit growth. The central bank also signaled that it will increasingly provide lira liquidity to Turkey’s banking system by way of more expensive channels.
Toward the end of September, Turkey’s central bank surprised investors with an official 200-basis-point increase in the one-week repo auction rate from 8.25% to 10.25%. This was the central bank’s first official interest rate increase in about two years. The central bank also made a similar move to increase its overnight lending rate from 9.75% to 11.75% and its late liquidity window facility rate from 11.25% to 13.25%. T. Rowe Price sovereign analyst Peter Botoucharov believes that further monetary tightening is likely.
Brazilian Stocks Decline
Stocks in Brazil, as measured by MSCI, returned -3.26% in the third quarter. The market significantly lagged the MSCI Emerging Markets Index, which returned 9.70%. The real fell about 2.7% versus the U.S. dollar, which hurt returns in dollar terms.
Brazilian assets were volatile at times due to concerns about the government’s commitment to fiscal discipline amid growing pressure from the public and from some politicians, who are demanding that the government increase spending to lift the economy. Although some metrics have improved, the broader economy continues to struggle and may not get much additional support in the form of central bank interest rate cuts.
In early August, Brazil’s central bank reduced its benchmark lending rate, the Selic rate, from 2.25% to 2.00%, an all-time low. At that time, central bank officials noted that “the remaining space for the use of monetary policy, if any, should be small.” As a result, T. Rowe Price sovereign analyst Richard Hall was not surprised when the central bank refrained from reducing rates again in mid-September. He believes, however, that policymakers may be willing to consider another 25-basis-point interest rate reduction at some future point.
South African Equities Lag Broader Emerging Markets
South African stocks, as measured by MSCI, returned 3.74% in the third quarter versus 9.70% for the MSCI Emerging Markets Index. The rand’s 4% appreciation versus the U.S. dollar lifted returns in dollar terms.
In July, the South African Reserve Bank reduced its benchmark lending rate, the repurchase rate, from 3.75% to 3.50%. However, the central bank refrained from cutting rates in mid-September. Some equity investors were disappointed that the central bank was not more aggressive in reducing interest rates.
Contributing to South Africa’s economic woes is the unreliability of electricity due to poorly maintained equipment operated by state-owned utility Eskom. Another entity requiring significant government support is South Africa Airways. Toward the end of September, there were indications that President Cyril Ramaphosa’s administration would pursue a costly bailout of the airline—which is contrary to Finance Minister Tito Mboweni’s belief that the airline should be liquidated. Speculation is growing that Mboweni may resign due to the apparent lack of support from Ramaphosa.
Major Index Returns
Total returns unless noted
As of 9/30/2020
Figures shown in U.S. dollars
|U.S. Equity Indexes|
|Dow Jones Industrial Average||8.22||-0.91|
|Nasdaq Composite (Principal Return)||11.02||24.46|
|Global/International Equity Indexes|
|MSCI Emerging Markets||9.70||-0.91|
|MSCI All Country World||8.25||1.77|
|Bloomberg Barclays U.S. Aggregate||0.62||6.79|
|Bloomberg Barclays Global Aggregate ex-USD||4.14||4.77|
|Credit Suisse High Yield||4.91||-0.62|
|J.P. Morgan Emerging Markets Bond Global||2.28||0.37|
Past performance cannot guarantee future results.
Note: Returns are for the periods ended September 30, 2020. The returns include dividends and interest income based on data supplied by third‑party provider RIMES and compiled by T. Rowe Price, except for the Nasdaq Composite Index, whose return is principal only.
Sources: Standard & Poor’s, LSE Group, Bloomberg Barclays, MSCI, Credit Suisse, Dow Jones, and JP Morgan (see Additional Disclosures).
What We're Watching Next
Investors face an exceptionally uncertain environment in the final weeks of 2020. In the U.S., the economic recovery is continuing, but its pace appears to be slowing considerably, most prominently in terms of waning job gains. Most observers agree that some additional stimulus will be needed to speed the recovery, but the prospects of a broad-based fiscal package seemed to waver at the end of the third quarter—particularly as the controversy over the replacement of Justice Ruth Bader Ginsburg on the Supreme Court has heightened political tensions that were already elevated in advance of the U.S. election.
Most other major economies are seeing similar patterns. Manufacturing chains are back up and running, and the International Monetary Fund sees the global outlook as “less dire” than it did in June. Nevertheless, many retailers and other services firms in the global “bricks and mortar” economy may find it impossible to remain solvent, particularly if a second wave of the coronavirus turns away cautious consumers. Virus trends have been especially worrisome this fall in Europe, where the increased probability of the UK leaving the EU without a trade deal by the end of 2020 is creating an additional layer of uncertainty.
But not all “risks” are to the downside. In nearly all developed economies, firms and consumers continue to benefit from record-low interest rates, while much of the massive fiscal stimulus put in place earlier in the year has helped avert the pattern of accumulating downward momentum that characterized the financial crisis a decade ago. In the U.S. and elsewhere, many consumers appear to have the wherewithal to increase spending as they grow more confident—a trend that sentiment gauges indicate is already in place.
The biggest boost to confidence, of course, would come from a successful coronavirus vaccine, as well as effective and widely available treatments for COVID-19. Our health care team includes analysts with medical and scientific backgrounds, and they are helping our investment teams keep abreast of developments. We have seen a number of large pharmaceutical companies make significant progress, but the timing of a commercial rollout of a vaccine and what proportion of the population will choose to take it remain open questions for investors.
The sharp rebound in the major equity benchmarks has been driven in large part by gains in shares of fast-growing mega-cap technology and internet-related firms, which have benefited mightily from the accelerated shift to the online economy. As the global economy heals, even if gradually, it’s possible that value stocks, which are less expensive on a relative basis than they have been in nearly two decades, could benefit from the updraft. We expect that non-U.S. shares, particularly those in emerging markets, may also benefit from a market rotation. However, we have seen periods of short-lived rotations in the past, and investors need to consider rebalancing techniques in order to achieve proper diversification. We believe that selectivity will remain key, however, and we will continue leveraging our extensive global research capabilities and strategic investing approach to seek out opportunities.
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