Client Communication - Madison Commentary Report | 3Q 2020

The most notable characteristic of stock market performance since March has been its steady rise against an economy deeply scarred by the Covid-19 pandemic. That trend reversed in the final month of this past quarter as the market suffered its worst September in almost a decade with the S&P 500® Index dropping -3.8%, bringing the quarter return for the Index to a still robust 8.9%. This effectively erased the deep loses of February and March, bringing the year-to-date return to 5.6%. In the end, the quarter followed the previous quarter's trend in terms of the best market performance being centered on the Consumer Discretionary and Technology Sectors with particularly strong contribution coming from mega-cap companies. The influence of a handful of the largest companies has been an important driver of returns: at quarter end the five largest companies in the S&P 500 represent 22.5% of the total index, surpassing the previous peak of 18% at the market peak of the technology bubble in 2000.

One notable reversal for the final month of the quarter was the outperformance of value stocks over growth stocks, reversing a trend which had produced a wide performance dispersion between these two categories. The large-cap Russell 1000® Growth Index dropped -4.8% for the month while the Russell 1000® Value Index was down -2.6%. This disparity was at odds with the powerful recent trend. For the quarter, the Russell 1000 Growth Index was up 13.2% compared with just 5.6% for the 1000 Value Index and the year-to-date gap is even more extreme. The growth-value dispersion has been even more pronounced for smaller stocks, with Russell's Mid Cap Growth Index up 13.9% for the year through September 30, while the Russell Mid Cap Value Index struggled at -12.8%, a huge gap of 26.7%. These index disparities reflect directly on how over the past six months investors have preferred certain sectors, particularly technology-driven companies, many of whose businesses have been boosted, rather than hurt, by the pandemic. The shift in September could be a sign that this trend overshot, producing excess valuations. It could also mark a sense that investors are hopeful the economy is working its way through the pandemic, a sentiment encouraged by the prospect for vaccines. On the political side, the possibility of a change in administration may have also been a driver, since the large growth companies that led the market could be adversely affected by anti-trust and tax policy shifts.

Another reason for the market pause in September was the realization that a second round of fiscal stimulus might be delayed, reduced, or even forgone. That did not affect the main engine behind the sixth-month stock rally, the Federal Reserve's aggressive stimulus which translated into lower loan rates which in turn have sparked housing and car sales.

Looking forward we see an extended period which may be described as riding out the Covid-19 and pre-to-post election storm. This period may very well turn out to be longer than is generally anticipated. It is likely we will need a globally distributed vaccine to move beyond the worldwide pandemic-sparked economic slowdown. Even as we move beyond Covid-19, the economic landscape for many sectors and individual businesses will likely be clouded at best and may take a significant period of time to clear. Many who have been laid off, furloughed or lost jobs face an uncertain future once stimulus is geared down. This may impact consumer spending, financial companies and other businesses tied to an economic recovery. And as if we needed more anxiety, we are looking at a contentious presidential election with unknown post-election complications, with potentially significant changes to the makeup of Congress. This adds to uncertainty as many companies and sectors may face higher taxes and revised regulation.

For these reasons, and for others that may yet develop, we believe retaining a finely honed risk consciousness is the way to approach today's and tomorrow's markets. The turn of sentiment in September towards more reasonably valued companies is one we find heartening and perhaps a harbinger of what we could expect through the end of the year and into 2021.