by Shawn Narancich, CFA
Executive Vice President

For many, 2020 has been a year to forget. Headlined by the COVID-19 pandemic and the ensuing global response, stimulus from central banks and governments has helped limit the damage, as the U.S. economy has now experienced its shortest and steepest recession ever. Although investors have made money this year by owning large cap U.S. stocks, the gains have been narrowly dispersed among a select group of tech and communication services stocks. As the chart below depicts, the headline S&P 500 return for the first three quarters of 2020 completed this week is a respectable 5.6 percent, but excluding the robust gains of just five select mega cap names – Facebook, Alphabet (Google), Amazon, Apple and Microsoft – the broader is actually down so far this year.

Tales of the Tape

No surprise, so far this year the best performing sector of the market is “growthy” technology, which houses two of the “FAAAM” stocks. Growth in earnings driven by productivity enhancing software, cloud computing, and a 5G wireless network cycle to come are key reasons we continue to own a market weight of technology stocks within the equity portion of client portfolios. And while we are overweight the more attractively valued communication services sector, we have recently added client exposure in other traditional cyclical sectors that may benefit from the economy’s budding recovery.

A New Cycle

The world is learning to live with the coronavirus – whether it be social distancing and masks, or more effective treatments for people who have contracted the COVID-19 disease – and economic recovery is taking hold in the absence of widespread lockdowns. Aided by fiscal stimulus and low rates engineered by the Fed, housing is booming, retail sales have achieved a V-shaped rebound to levels now exceeding pre-pandemic levels and manufacturing activity has risen markedly in response to low inventories and budding demand. Against this backdrop, and with a vaccine likely to be widely available at some point next year, our expectation is for continued growth in retail sales and housing activity that should benefit select stocks within the cyclical sectors of the market. We expect improving market breadth amid a “democratization” of investment returns across value-leaning sectors that to this point have lacked participation in the market’s advance.

Economic Growth Normalizing

Emerging from this spring’s lockdown, the U.S. economy is likely to have grown by as much as 35 percent annualized in the third quarter, an exceptional number that will be revealed in its magnitude later this month. Meanwhile, we are beginning to witness an economy transitioning to less extraordinary rates of recovery. Manufacturing activity as measured by the ISM Manufacturing Index (ISM) reported earlier this week showed a moderating rate of expansion. While the September jobs report released today showed net job gains of 661,000 that, while still outsized in magnitude, declined by more than half in comparison with August levels. While the ISM and payroll reports missed consensus expectations, they do not deter our belief in the viability of the economic recovery at hand.

Third Quarter Earnings Lie Ahead

After being treated to a couple of early reports this week, including consumer staples blue chip Pepsi, investors can look forward to an accelerating cadence of earnings reports in the month ahead. While the economic recovery referenced above will have provided the primary stimulus to company earnings, we believe a less heralded aspect of earnings recovery may come from the currency markets. As depicted in the chart below, the average value of the trade weighted dollar – calculated by weighting trade flows to key trading partners in Europe, the UK, Canada and Japan – decreased by 4 percent in the third quarter.

The quarter just ended is the first period in over two years when we have seen such a U.S. dollar decline. The reason this matters is because multinational companies like McDonald’s, Honeywell, Apple and Microsoft report their earnings in the U.S. dollar and therefore get a boost from translating foreign sales and profits into additional dollars during periods of decline like those markets just experienced. As earnings climb back from the second quarter abyss, a weaker dollar – tied to extraordinary levels of U.S. monetary stimulus and the incipient economy recovery – should prove to be a tailwind for corporate America.

Week in Review and Our Takeaways:

Investors closed the books on a third quarter that saw select growth stocks power the market to high single-digit returns for the period
While the U.S. economic recovery continues to unfold, its dramatic rate of third quarter growth will moderate

Disclosures

All references to companies above are provided as examples or for educational purposes only and are not meant to be recommendations.