The third quarter felt like a roller coaster ride for investors, as optimism around lessening state restrictions and hope for another round of government stimulus sent markets higher in July and August, continuing the historic recovery seen in the second quarter. And then came September, which brought a resurgence in Covid-19 cases in both the US and Europe. Concern and uncertainty surrounding the course of the virus and government responses mounted as stimulus talks stalled, and the markets saw a significant pullback when stocks posted losses for four weeks in a row.
Even with the September reversal in investor sentiment, equity indices still posted strong returns for the quarter. Bond returns were also positive but more modest. In fact, the second and third quarters had the best two-quarter performance for the S&P 500 since 2009, the last time the world was recovering from a major stock market downturn. While uncertainty continues to be a mainstay of the pandemic era, there are some reasons for cautious optimism. The US continues to add jobs as businesses reopen with new guidelines, and the unemployment rate has come down from its April peak of 15% to just below 8%.
In contrast to the second quarter, US small cap companies trailed their larger counterparts in the third. Larger companies are generally seen as more mature businesses with reserves to lean on during tough times. Smaller companies historically demonstrate higher growth rates, yet their perceived vulnerability has prevented them from recovering to the same extent, as they trail for the year by a wide margin.
Developed and emerging markets also had a strong quarter, boosted by countries like China and South Korea, which were further along in containing the virus, and a weakening US dollar. Emerging markets posted the strongest return for the quarter among all major indices covered.
Growth outperformed value in the US and overseas as technology and biotech sectors benefited from the COVID-19 economy. However, it is worth pointing out that this divergence is driven by a handful of big names, as opposed to a more systematic difference in performance between the two styles. Furthermore, these big names that have done remarkably well for the year were also among the largest detractors in the September pullback.
In fixed income, US Investment grade bonds posted modest returns in the third quarter and boasted the highest return of the major indices shown above for the year. Municipal bonds were also positive for the quarter. These high credit quality bonds have, except for a brief period of illiquidity in March, acted as a ballast in client portfolios, helping temper the volatility that has been commonplace in 2020. Lower credit quality US bonds have breached positive territory for the year as the rally that started in the second quarter continued. Emerging markets bonds were positive for the quarter but are still down for the year as lenders keep an eye on countries hit particularly hard by the drop in global demand.
As we count down the days to the election, we expect more surprises and volatility. Over time, we expect the market to continue to advance, but the short term will probably continue to bring us surprises, one after another. Maintaining strong discipline through volatile periods and a consistent focus on long-term objectives will allow investors to get through all this in reasonably good shape.
 Gunjan Banerji and Peter Santilij, “Turbocharged Stocks Blast Off”, Wall Street Journal, October 1, 2020.
 Caroline Valetkevitch, “U.S. stocks post sharp quarterly gains, but caution continues to dog outlook”, Reuters, September 30, 2020.
 Civilian unemployment rate, U.S. Bureau of Labor Statistics, accessed October 5, 2020. https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm.
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Dow Jones Industrial Average Index: measures the performance of 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the NASDAQ.
Russell 3000 Index (U.S. Stock Market): measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. These securities are traded on the NYSE, NYSE MKT, and NASDAQ.
S&P 500 Index (Large Cap U.S. Stocks): measures the performance of large capitalization U.S. Stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, NYSE MKT, and NASDAQ. The weightings make each company’s influence on the Index performance directly proportional to that company’s market value.
Russell 2000 Index (Small Cap U.S. Stocks): An unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index, representing approximately 10% of the total market capitalization of that index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group owns the Russell Index data, including all applicable trademarks and copyrights.
MSCI EAFE Index (International Developed Stocks): The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
MSCI Emerging Markets Index (Emerging Markets Stocks): is a Morgan Stanley Capital International Index that is designed to measure the performance of equity markets in 23 emerging countries around the world.
Bloomberg Barclays US Aggregate Bond Index (U.S. Bond Market or Investment Grade U.S. Bonds): includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.
Bloomberg Barclays Muni Bond Index 1-10 Yr Blend (1-12) (Int-Term Municipal Bonds or US Municipal Bonds): A market value-weighted index which covers the short and intermediate components of the Barclays Capital Municipal Bond Index. The 1-10 Year Municipal Blend index tracks tax-exempt municipal General Obligation, Revenue, Insured, and Prerefunded bonds with a minimum $5 million par amount outstanding, issued as part of a transaction of at least $50 million, and with a remaining maturity from 1 up to (but not including) 12 years.
ICE BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index (High Yield U.S. Bonds): Tracks the performance of US dollar-denominated below-investment-grade (BBB rated) corporate debt publicly issued in the US domestic market. Qualifying bonds are capitalization-weighted provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis.
JPM GBI EM GD USD Unhedged Index (Emerging Markets Bonds): The JP Morgan EMBI Global Diversified is a uniquely weighted index that tracks total returns for U.S. dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities. The index limits the weights of countries with larger debt stocks by only including a specified portion of these countries’ eligible current face amounts of debt outstanding.
JPM EMBI GD Index: J.P. Morgan Emerging Markets Bond Global Diversified Index (EMBI Global Diversified) tracks the returns for U.S. dollar-denominated debt instruments issued by emerging market sovereign and quasi- sovereign entities: Brady bonds, loans, Eurobonds. The index limits the exposure of some of the larger countries.