November 12, 2020
A Squishy Market
The spike in COVID-19 cases created a volatile market and curbed growth in October, but the trend remained positive.
On Nov. 5, we sat down with Pacific Asset Management’s Dominic Nolan, senior managing director, and Ryan Smith, to get their insights on the markets’ performance in October, including the impact of the sharp increase in COVID-19 cases. Pacific Asset Management LLC is the sub-adviser for the Pacific Funds℠ Fixed-Income Funds.
We have seen an uptick in COVID-19 cases in the U.S., as well as globally. And it’s really no surprise that October saw the biggest uptick in volatility since March. Can you provide some context on what happened in markets in October?
In a nutshell, I think the markets were really trying to digest three pretty big elements. One, the increase in COVID-19 cases. Two, the prospects of a stimulus package. And three, the outcome of elections. And any time you have that uncertainty, obviously as a risk investor, you want to be compensated for it.
I’ll share with you some numbers. For the month of October, the S&P 500® index was down about 2.6%, but for the past three months, it’s up 1%. So, year-to-date the S&P 500 is still positive. But here’s what’s most interesting to me: The Russell 1000® Growth Index, which led the stock market’s rally this year, was down 3.5% in October. Meanwhile, the Russell 2000® Value Index, which represents the more traditional economic business models, was up 3.5%. That 7% gap is a big disparity. Year-to-date, the Russell 1000® Growth Index is still up 20%, and the Russell 2000 Value Index is down 18%. That’s a 38% delta in performance.
Fixed-income news in October was pretty boring. The Bloomberg Barclays U.S. Aggregate Bond Index was down 45 basis points, in large part due to rates moving a bit higher. Year-to-date, though, the index was still up 6%. The Barclays Capital U.S. High Yield Corporate Bond Index was up 49 basis points. Year-to-date the index is up 1%. Bank loans were up marginally, 19 basis points in October and down about a half-percent year-to-date.
In general, I’d say it was a “squishy” market in October. For the past three months, the leader in performance was actually the Russell 2000 Value Index, but it’s still by far the biggest laggard year-to-date.
How are the sectors performing that are greatly impacted by COVID-19?
Let’s look at spending trends from the Bureau of Economic Analysis daily credit-card analytics, which is a fraction of the picture, but it is a data point. For airlines, entertainment, lodging, and gaming, I would categorize spending as slightly improving. Airlines were down 75% year-over-year in August. By the end of October, they were down 62%. In August, entertainment was down almost 80% year-over-year. Now it’s down about 66% year-over-year. So, those are slight improvements, but it’s still pretty bleak relative to previous years.
Part of the market uncertainly had to do with guidance. By Labor Day, we had strong economic numbers, which meant people were getting together or going out. But three weeks later, we found the Labor Day activities led to increases in COVID-19 cases. So, guidance from some of the COVID-impacted sectors is certainly much more uncertain now. Those sectors are generally expecting a weaker fourth quarter than originally forecasted, which led to some of the volatility. From a lodging perspective, Hyatt Hotels Corp. has been genuinely the most cautious, and it’s now getting cautious on the first quarter of next year. What you’re seeing in lodging is no surprise; drive-to hotels and economy to mid-sized hotels tend to be doing pretty well. Urban and full-service hotels are not doing well. You can take that same theme over to restaurants. Fine dining is not doing well. The quick-serve, fast-casual restaurants are hanging in.
The gaming situation is mixed. The sector had continued to improve, but now the outlook has gotten cloudier due to the increases in COVID-19 cases. At the same time, though, the gaming in China continues to do well. I think there’s optimism looking at China which is truly seeing a recovery.
Who’s doing well?
Furniture is up 27% year-over-year, and home improvement is up 28%. Online retail is up 70% year-over-year.
When you wrap it up, credit-card spending two months ago was down 9% year-over-year. Now, it’s down only 4%. Total card debit and credit has slightly improved. So again, getting back to the recovery progress, I would say the trend continues in the right direction, but guidance is certainly trickier right now because of spikes in COVID-19 cases.
How are you viewing the economy going forward?
When you look at the underlying behavior of businesses, we are seeing substantial cost cutting, and I expect that will continue. Also, expectations for fourth-quarter growth are mostly positive, but are being lowered mostly because of the spreading pandemic. Don’t expect interest rates to be a problem. Interest rates probably would have been up for debate if you had blue wave. The thought of rates really moving higher is no longer, I think, the base case.
So it gets down to: Is there going to be enough stimulus to help bridge the COVID gap and are companies setting themselves up to crush earnings next year? The ongoing cost cutting is going to lead to some operating leverage for a lot of different industries. And what I mean by operating leverage is incremental profits when the economy picks up is going to mean more earnings because they’re eliminating a lot of the costs, which means margins should increase.
The fundamentals are still trending in the right direction, although at a less bullish pace given the increases in COVID-19 cases and the possibility of governments limiting more economic activity. To me, the COVID issue needs to be balanced by a stimulus package, which hopefully we can get to in the next few months. All of those factors tell me that spread compression is still in the cards. In April, we were pretty constructive and remain constructive on credit. If you told me the stimulus package is going to be extremely low, then I’d say, “Okay, you might have spreads widening and especially on the traditional businesses,” but I just don’t think that is base case. Everything else though seems to be pretty constructive over the next 12 months.
And remember markets are forward looking, so I’m very much in the camp that we’ll see spread compression without much rate pressure, which is good for credit.
So last question, as always: What non-economic thought will you share today?
I’m trying to teach this to my kids: Two of the most important relationships we have in our lives is our relationship with time and our relationship with energy. Those are relationships that hopefully you control, but we’re doing it in a world where so many outside factors are trying to take that control away from us. So, if we can manage those outside factors and control our relationship with our time and our energy, I think we’ll end up on a much more fulfilling path.
Pacific Asset Management LLC is the sub-adviser for the Pacific Funds Fixed-Income Funds. The views in this commentary are as of November 6, 2020 and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment. The opinions expressed herein are subject to change without notice as market and other conditions warrant. Any performance data quoted represents past performance which does not guarantee future results. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. Sector names in this commentary are provided by the Funds’ portfolio managers and could be different if provided by a third party.
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