The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Midyear Outlook:
- U.S. economy: Looking for a full recovery by late 2021, albeit with high unemployment.
- Global economy: More monetary and fiscal stimulus is needed to keep businesses afloat.
- Policy watch: No Fed interest rate hikes until well after the economy has healed.
- Fixed income: Lean into higher-risk assets to generate income.
- Equities: Focusing on quality across the board (and dividend payers, too).
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“I think I’ll try defying gravity.” — Elphaba, Wicked
The gale force housing recovery is but a gentle tailwind for the economy
While not immune to the forces of the COVID-19 pandemic, the housing market has been far less affected than other parts of the economy, particularly service industries. July data released last week signaled that the housing sector continues to enjoy a true “V-shaped” recovery from its April bottom. Housing starts surged 23% last month, and building permits weren’t far behind, jumping 19%.6 With those kinds of numbers, it’s no surprise homebuilders are feeling especially bullish, as measured by the NAHB/Wells Fargo Housing Market Index. The index hit its highest level in August, matching the all-time peak set in 1998.7
Why has housing market data been blowing the doors off forecasts?
- “Below basement” mortgage rates. According to Bankrate, the 30-year fixed-rate mortgage fell to a record-low 3.14% last week. Mortgage rates are tied to the 10-year U.S. Treasury yield, which ended the week only modestly higher than the lowest close it ever recorded (0.52%, in early August).8 Investor concern about the long-term health of the economy, along with the Federal Reserve’s monthly $80 billion quantitative easing purchases of U.S. Treasuries, has driven the 10-year yield — and thus mortgage rates — to these historic lows.
- Solid household balance sheets. U.S. savings rates have increased dramatically during the coronavirus crisis, the result of rising personal income and falling consumer spending. Meanwhile, the U.S. stock market’s furious rally since March has pushed major benchmarks, including the S&P 500 Index, into positive territory for the year to date. Taken together, these factors have helped make the average household more financially secure (for now) than they were at the beginning of the year, and in a better position to buy a home. (Of course, this isn’t true for the tens of millions who have lost jobs.)
- Robust demand, possibly aided by a greater desire on the part of prospective homeowners to relocate into single-family homes outside major cities in light of the pandemic.
That’s the good news. The less good news is that residential construction, even if it’s booming, isn’t a large enough part of the U.S. economy to offset declines in business investment or consumer spending. Case in point: home construction grew at a 19.0% annualized rate in the first quarter but added only 0.68% to GDP.9 In the second quarter, it declined at a 38.7% annualized rate (an even bigger collapse than the 32.9% plunge in the economy as a whole), but this outsized drop subtracted just 1.76% from GDP.10
Still, even if the housing market’s ability to drive overall economic growth is limited, a healthy homebuilding sector is preferable to a weakened one. And construction is traditionally a leading indicator of increased consumer spending, as homebuyers fill and adorn their new abodes.
Taking stock of stocks thus far in 2020
Global equity market performance has been surprisingly good in 2020, considering the severe financial and economic headwinds generated by the coronavirus. The first half of the year produced a wide range of results across equity sectors and geographies. In contrast, the third quarter has seen far less dispersion of returns.
Here are some highlights:
- Growth has maintained market leadership. Despite some short-term periods of outperformance by value stocks in July and the first half of August, U.S. growth shares continue to lead the way for both the third quarter and year to date. Investors have been willing to pay higher multiples for companies with the potential to consistently grow their earnings.
- Emerging-market (EM) equities have made a comeback. One of the worst laggards in the first two quarters, EM equities have gained over 10% in the third.11 Non-U.S. developed-market shares have also rallied but trail their EM counterparts for the quarter to date. The weakening of the U.S. dollar in recent weeks has given international stocks more of a fighting chance to match U.S. returns. In addition to making it easier for non-U.S. firms to service dollar-denominated debt, a softer greenback boosts overseas returns when translated into dollars.
- Small caps have delivered big gains, too. After struggling in the first half of the year (-13.0%), U.S. small caps (+7.9% in the third quarter12) have rallied hard. Bargain hunters have been enticed in part by small caps’ attractive valuations.
- Sector winners and losers show some stark contrasts. Both the consumer discretionary (+15.5%) and consumer staples (+9.7%) sectors of the S&P 500 Index have been in fine form during the third quarter. In general, economically sensitive cyclical sectors such as industrials (+11.2%) and materials (+9.8%) have had a better run than their more defensive counterparts, which include “bond proxies” real estate (+2.9%) and utilities (+5.2%). But not all cyclicals have performed well. Energy remains the worst-performing sector for the quarter (-5.1%) and the year to date (-38.6%), hampered by low oil prices. Meanwhile, information technology (+12.8% for the quarter) is outperforming all other sectors year to date (+29.7%). (All S&P 500 Index sector returns sourced from FactSet.)
What’s been fueling the rise in equity markets? In large part, it’s hope that the U.S. could see a full recovery back to pre-pandemic economic and earnings peaks, especially if one or more promising vaccine candidates pans out soon. This optimism, coupled with solid economic data from abroad, appears to be enough to sustain high equity valuations and allow for broader participation in the rally.
Of course, there’s plenty of time left in 2020 for a few more twists and turns in the markets, including underlying sector leadership. For example, a slowdown in the economy or another significant rise in U.S. COVID-19 cases could derail cyclical stocks while allowing out-of-favor sectors (like utilities) to regain their footing.
The U.S. presidential election will also play a role in equity market performance. While we don’t see clear evidence that any particular outcome is priced in, financial and energy firms could come under increased regulatory scrutiny under a Biden administration. Investors may recall that those sectors soared in the wake of Donald Trump’s unexpected win in 2016 — for precisely the opposite reason.